Jan 28, 2009
Executives
Gregory E. Johnson - President and Chief Executive Officer Kenneth A.
Lewis – Executive Vice President and Chief Financial Officer
Analysts
Mike Carrier – UBS Robert Lee – Keefe, Bruyette & Woods William Katz – Buckingham Research Michael Kim – Sandler O’Neill & Partners Craig Siegenthaler – Credit Suisse Kenneth Worthington - JP Morgan Jeff Hobson – Stifel Nicolaus Cynthia Mayer – Merrill Lynch Matt Snowling – Friedman, Billings, Ramsey & Co.
Operator
Welcome to Franklin Resources’ earnings conference call for the quarter ended December 31, 2008. Please note that the financial results to be discussed in this conference call are preliminary.
Statements made in this conference call regarding Franklin Resources Incorporated, which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements.
These and other risks, uncertainties and other important factors are described in more detail in Franklin’s recent filings with the Securities and Exchange Commission including the risk factors and MD&A sections of Franklin’s most recent Form 10-K and 10-Q filings. (Operator Instructions) Mr.
Johnson, you may begin your conference.
Gregory Johnson
Good afternoon everyone. This is Greg Johnson, CEO of Franklin Resources and joining me as always is our CFO, Ken Lewis.
Stating the obvious it was a difficult quarter to be in the asset management business. Revenues, earnings and flows declined on the back of very weak markets with the S&P and Down over a 21% decline.
If there is any silver lining we are pleased to see that investment performance continues to make progress and our cost containment initiatives that we initiated over a year ago are starting to have an effect on the control of expenses. We are very focused still on cost containment at the company.
Quickly looking at assets, assets declined from $507 billion to $416 billion and average AUM declined just over 20% quarter-to-quarter. Looking at AUM by investment objective, the major shift towards fixed income continues and fixed income represented 32% of our assets versus just over 28% in the prior quarter and that has had an effect on our tax rate which Ken will speak about in a few minutes.
Looking at the flows, outflows increased to $18 billion from $8.6 billion. Sales were down 27%.
Redemptions were flat quarter-over-quarter. Our flows did not benefit from the flight to money market funds in the past quarter and money funds represented 2% of our assets versus 40% for the overall mutual fund industry.
Looking at the net flows by region, in the U.S. net new outflows of approximately $12 billion more than doubled from the prior quarter of $5.6 billion.
Sales decreased 10% while redemptions increased 20%. Tax free funds, which has been one of the best selling categories over the past year had net outflows of $1.7 billion.
There was a lot of volatility in the quarter in the munie markets specifically with our Cal tax free and our high yield tax free net outflows in that category. Our largest fund, the Franklin Income Fund, had net outflows of $2.8 billion versus $1.4 billion representing the largest outflow for any of our funds.
Outside of the U.S. sales decreased by almost 40% and redemptions increased by 23% but it is important to note that this decrease in sales was primarily due to our India Treasury Management Funds which had $5 billion less in sales and there was a dislocation in that market with a lot of the money fund issues we are experiencing around the globe.
Given the market environment we initiated an international sales campaign which focused on fixed which highlighted the Franklin U.S. Government Fund.
It was our best selling product during the quarter with third-party net new flows of approximately $520 million compared to a five quarter in the fourth quarter. Looking at the flows by client type on retail we had net new outflows of $15 billion compared to $8.8 billion in the prior quarter and the net new outflows was again a shift on the fixed income products that have been generating positive flows in prior quarters.
The institutional side had net new outflows of $3.1 billion versus $200 million of inflows, a 25% decrease in sales with an 8% increase in redemptions. Most institutions during this kind of volatility were taking a wait and see approach during the quarter which ended in not having a lot of big wins without any funding from any institutions during the quarter.
We expect to see this turn around this quarter with searches increasing and fundings from prior wins occurring this quarter. The largest single inflow was a $250 million Global Equity mandate from a pre-existing Korean client.
High net flows were about break even for the quarter. Flows by investment objective, net outflows for equity products decreased 12% to $8.5 billion.
Global equity contributed to most of the increases in net new outflows declined to $6.5 billion from $7.5 billion in the prior quarter. Domestic net new outflows decreased to $2 billion from $2.2 billion and on the hybrid side net new outflows from hybrid products more than doubled to $3.2 compared to $1.4 in the prior quarter.
Again, the majority of that is our largest fund, the Franklin Income Fund. Fixed income swung to outflows just as industry flows did overall and posted net new outflows of $7 billion versus inflows of $2.2 billion.
Again, $5 billion of that in sales was due to lower India Treasury Management Fund and our global international and tax free fund which were some of our best selling products in recent quarters combined net outflows of $7.3 billion versus outflows of $2.3. Money funds posted net new flows of $500 million which is a 2/3 increase from the prior quarter.
Looking at investment performance not a whole lot of changes. Overall we are pleased to see that the one-year performance numbers for the group ticked up from 55% of our assets in the top two quartiles to 60% today.
Of note, on the taxable fixed income side we saw the one-year performance improve to 91% of our assets in the top two quartiles and that was on the back of the Franklin Strategic Income Fund which performance improved. Tax free saw significant improvement in the one-year numbers increasing 63% of assets to up over 81% of assets.
Looking at the equity side the Templeton side decreased and that was on the back of the growth fund and I would say for the year Templeton has about average performance for the one-year period but the growth fund did slip down to third which represents 50% of our assets. Mutual series continues to have excellent performance in every time period; 1, 3, 5, 10 at least 88% of the assets were in the top quartile.
Franklin Equity, as we mentioned the Franklin Income Fund with its focus on financials and high yield bonds continues to lag its peer group and that represents 51% of our assets but many of the other Franklin Equity Fund performance increased. The small mid cap fund which is 5% of our assets and the Franklin Balanced Fund another 5% of our assets all saw improved performance in the quarter.
I will now turn it to Ken for operating results.
Kenneth Lewis
Thank you Greg. Hello everyone.
As Greg mentioned this was a challenging quarter for all asset managers as market conditions drove assets under management to levels last seen several years ago. We thought that our response on the cost management side was effective.
Expenses declined over $200 million from last quarter and more than 33% from the prior year. Operating income decreased 38% from last quarter to $268 million and net income decreased 60% from last quarter to [$181] million with investment losses and increased tax expense.
Included in the results this quarter are over $100 million of unrealized investment write downs to market. Earnings per share decreased $0.59 from last quarter to $0.52.
Investment management fees decreased 27% from the prior quarter primarily due to the decline in daily average assets under management and the further mix shift towards lower fee generating fixed income products. As you may recall from previous discussions most of our funds generate fees based on average daily added values and due to the volatility and the timing of the fluctuations in assets under management in this quarter the daily assets under management is lower than the simple monthly average and that is primarily why you are seeing what looks to be a much lower fee rate compared with the prior quarter.
We estimate that our average fee rate using the daily averages was about 57 basis points versus the 54 basis points you might calculate using the monthly average. Underwriting distribution fees decreased over 28% in line with deeper sales and assets under management.
Shareholder servicing fees declined almost 5% compared with a 3% increase in billable accounts. That disconnect is due to an increase in closed accounts that generate lower fees.
Other net was negative $4.1 million this quarter. Included in this number is an $18 million write down of our retained interest in securitization transactions that represent our contractual right to receive interest from the full securitized loans that we service.
On the expense side, as we have talked about, operating expenses decreased over $208 million or 23% as we focused our attention on expense management to a variety of measured and deliberate steps. Most of this decrease was from cost cutting.
Some of it was due to seasonality and lower volumes. A portion of the cost reductions were headcount related this quarter and included an approximately 2% reduction in October that was followed up with an additional 4% reduction last week.
Included in the compensation benefits expense line is an $11.2 million severance charge related to the October reduction offset by nonrecurring expense reductions of $3-5 million. Looking forward we expect a charge of around $13 million in the next quarter’s numbers for last week’s reductions as well as a seasonal uptick in compensation expense related to payroll taxes.
Technology and occupancy expense decreased 17.3% quarter-over-quarter due to a decrease in consulting fees, part of which is seasonal, utilities and building maintenance and outsourced data services. Advertising and promotion expenses decreased $21.3 million or 46.8% quarter-over-quarter due to a combination of lower marketing support fees, cost cutting and about $5-6 million of seasonally low advertising expense.
We continue to believe that it is important to support our brands with advertising and are doing so albeit at reduced levels from what we have done in the past. Amortization and deferred sales commissions decreased 24% due to a decrease in Class A and Class C deferred assets and the accelerated amortization of $8 million that was included in the previous quarter.
Also this quarter included about $3 million of accelerated amortization. Lastly, on the expense side operating expenses other expenses decreased 27.3% as a result of lower legal and professional fees, travel, entertainment and other discretionary expenses.
Moving to non-operating income, other income net swung to a loss of $83 million this quarter due to several factors. First, sponsored investment product losses increased slightly over the previous quarter to $36.5 million and this line represents the mark-to-market of our C capital investments in our own funds that we consolidate and investment and other income net posted a loss of $45 million which was a $123 million decrease from the prior quarter.
The decrease mainly resulted from switch from net gains to losses in equity income from affiliates and increased other than temporary impairment on available for sale investments of about $34 million; increased realized loss on investment of about $17 million; unrealized mark-to-market losses on retained securities from our 2008 auto loan securitization $12 million; decreased interest income on yields and cash equivalents have declined materially about $9 million and decreased realized and unrealized foreign exchange gains of about $8 million. Now those are a laundry list of unusual items that occurred in the quarter.
It might be easier just to look at what was expected of this line item during the quarter. During the quarter we had earnings from cash and investments of about $25 million.
So that is an item we would expect to recur at probably lower rates as the yield on cash decreases in the future. The effective tax for the quarter was 34.9% due primarily to the change in mix of assets under management and related revenue.
The estimated percentage of taxable income earned in the United States increased 26% in the quarter and that probably is not too surprising when you consider the 26% decrease in the Templeton assets under management, Templeton funds are mostly managed offshore. The operating margin slipped to 27.7% this quarter which in this environment we feel is a pretty healthy margin.
Despite the difficult market conditions we continue our capital management activities. We increased the dividend by 5% in December and we repurchased 700,000 shares during the quarter.
Our total payout ratio for the quarter and current fiscal year was just under 78% and that is slightly below the 80-90% target we previously indicated. Cash and cash equivalents plus other current investments plus timed deposits are $3.1 billion at December 31 compared with $3.4 billion at September 30.
So that concludes my remarks. Back to Greg for some business highlights.
Gregory Johnson
Moving on to business highlights which seems like an oxymoron looking over the past quarter, I will mention a few highlights for the quarter. We did launch our RetireMetric sales and marketing campaign which is focused on developing retirement solutions to meet the changing needs of advisors and their clients.
We initiated the international sales campaign to focus on fixed income. We opened a local asset management office in Malaysia and we expect more mandates to fund this quarter somewhere around $500 million.
In the U.K. we are pleased to see that the Templeton Emerging Markets Trust received the Trust of the Year award for 2008 in the emerging markets category.
We also are pleased to see the continued excellent performance with our global fixed income group and in Canada the Templeton Global Bond Fund was awarded for the best Global Fixed Income Fund at the Canadian Investment Awards. With that we would like to open it up for your questions.
Thank you.
Operator
(Operator Instructions) The first question comes from the line of Mike Carrier – UBS.
Mike Carrier – UBS
First a question on the costs. When we are looking at the different buckets I know there is going to be some noise that you gave related to comp next quarter but primarily the other buckets, when we are looking at IT, advertising and other, X the seasonality you mentioned you had sort of a pretty good run rate given the current environment and if things were to worsen do you have some more flexibility there?
Gregory Johnson
I think the answer is in those specific line items probably a pretty good run rate if you adjust for seasonality there in the IT line and advertising line. With regard to the second question there is some flexibility in those line items particularly the IT line item if things were to get worse.
Mike Carrier – UBS
Part of the biggest shift in terms of flows that we saw was in the international fixed income bucket. Just wondering, granted there were outflows pretty much across all of the sectors or buckets during the quarter for the industry but I’m just wondering when you look through the products in that bucket whether certain things and certain customers you were really exiting?
Because on the institutional side when you look at the total flows it doesn’t seem that it was all fixed income. So any granularity on that and if you expected to sort of moderate to more normal levels?
Kenneth Lewis
It is hard to say. I do expect it to moderate because I think if you look at the flow activity it really correlates with what is happening in the financial services sector capital markets and when you get the headlines it is almost immediate on the retail side.
If you look at the industry flows in the quarter any kind of bond fund that was long-term, global bond funds, high yield munies, there was a very rough period there and there was a flight to quality and if you have another period and people run to treasuries you might see another blip in that but I think that was more of a one-term and I think the trend is improving and I think it is not something that people are abandoning. What I think is it is the most attractive sector that exists today.
Mike Carrier – UBS
On the tax rate, as long as the fixed income assets remain where they are relative to the equities should we still expect roughly a 35% tax rate or is there anything you can do to try and bring it down? Secondly, when you look at the non-operating income this is across all the asset managers this quarter and there is a lot of volatility and a lot of disclosure in terms of trying to figure out what is in there and trying to model it.
If I look at the different buckets in terms of the seed investments versus sort of that other income bucket when we look at the Q or the disclosure you give on the securities we can kind of break it out in terms of available for sale versus trading. But is there anything we should be looking at other than that in terms of can you give us an updated level of what the investments are currently?
Then going forward maybe we can try to mark them from those levels. Just any color there?
Gregory Johnson
First on the tax rate. There are a couple of items in the tax rate, discreet items this quarter, that pushed it up and if you assume that the mix will not change I think that maybe it is a little bit high this quarter so maybe you could take a little bit off that and it might not be 35% but it is in the ballpark going forward assuming the same mix that we have assumed in the first quarter.
On the other income not much has changed in the composition of the investments. You can look at the investments available for sale and the trading securities.
The investments I’d say are maybe weighted more towards global equity but they are basically they should model after our product offerings because most of it is seed money. So it should be pretty consistent with our AUM in terms of mix of the securities but there has been no fundamental shift in the strategy this quarter or for line.
Operator
The next question comes from Robert Lee – Keefe, Bruyette & Woods.
Robert Lee – Keefe, Bruyette & Woods
I’d like to go to the comp line for a second. How should we be thinking about going through somewhat larger headcount reduction and taking another charge.
I mean how should we be thinking about what kind of the target is, what that implies for cost saves in terms of compensation or otherwise going forward?
Gregory Johnson
I tried to give you a little bit of guidance there on the ins and outs. In the short-term you will have the severance charge that I mentioned and you will have an uptick in the taxes and the other thing to keep in mind in the first quarter is there are some components of the compensation expense that are tied to the company’s stock price as well as to some of our funds.
So some of the long-term awards are granted in our funds and they get marked so that is why you have a little bit of reduced expenses last quarter. Going forward I think the kind of ins and outs offset each other.
Kenneth Lewis
The other thing is it is always the bonus pool which is variable and we set that as we go. Obviously there is flexibility there either way with what the markets do.
Robert Lee – Keefe, Bruyette & Woods
If I look at the 6% headcount reductions, the last one and this one, is it the idea that you are taking $30 million a year out of the comp base, everything else being equal? 40 or how should we be thinking about that?
Gregory Johnson
Our estimate in terms of it coming out of the comp base it is probably going to be a few quarters before you see it stabilize. It is in the $20-25 million range.
Robert Lee – Keefe, Bruyette & Woods
If I could maybe ask a question on the auto business, obviously you had a couple of expenses and charges or whatever you want to call them related to that the last couple of quarters. I know it is a relatively small thing in the scope of the business, but it is a little bit of a drag right now.
Can you maybe give us some update on what the intentions are with that at this point? Are you still writing auto loans?
Have you stopped? Is there anything going on there that we should be aware of or thinking about going forward?
Gregory Johnson
On the auto loans we have definitely slowed down the volume there. We are writing, the estimate of what we are going to write on an annual basis is probably half the monthly volume we have been doing over the last five years.
It has kind of slowed down to a trickle. We have about $120 million in loans on the balance sheet.
So it has slowed dramatically and we are kind of keeping it contained if you will.
Operator
The next question comes from William Katz – Buckingham Research.
William Katz – Buckingham Research
Sort of following that last question and sort of a bigger picture question is at this point given everything the bank industry is going through and are still going through why are you bothering with a bank? I am sort of curious if you could talk strategically about that asset in general?
Gregory Johnson
The bank itself is part of the high net worth strategy and the auto loan business has been there for a very long time and have been through this on previous calls on how it has evolved. I think in part of the cost cutting initiatives we are looking at every single business line and the auto subsidiary is no exception.
I’m sure you would agree that if we did want to exit that business it would be the worst time to do that. We are looking at everything with more to come on that I suppose.
We’ll go through the portfolio of all our business lines.
Kenneth Lewis
The answer is we have to be in the banking business. That is part of the high net worth services that we offer and these write downs are mark-to-market and like many banks we feel there is more value in that security than where we are marking it today but the market is the market and our underwriting we still feel very good about and one would argue that this kind of dislocation in the market and spreads that we are getting today it is probably a good incremental [use of funds].
William Katz – Buckingham Research
Just to clarify your remarks, the residual cost saves associated with the last two reductions of the force that is more of a 6-month window until you start to see them or it is just being masked by the severance charges, from seasonality in this upcoming quarter?
Gregory Johnson
Probably I’d say maybe in 6 months but between 3-6 months you’ll see the full impact of the cuts. The first one we probably had 2/3 of the first cut in the first quarter and then this one you probably have two months again this quarter and then going forward it should normalize in quarter three.
William Katz – Buckingham Research
As you step back, I’m sort of curious, as you mentioned you thought things might be moderating a little bit. Can you give us a little update on what you are seeing, albeit I know it is early in the year, in terms of retail volumes and I wonder if you can separate your thoughts between U.S.
and non-U.S.?
Gregory Johnson
It is early but January tends to be a relatively strong month for the industry. I don’t think equity flows overall have come back to a typical January but certainly much better than the fourth quarter overall and we would be tracking that and I would say it would be similar as far as what we are seeing outside the U.S.
versus what we are seeing here in the U.S.
Operator
The next question comes from Michael Kim – Sandler O’Neill & Partners.
Michael Kim – Sandler O’Neill & Partners
Maybe just to start off with a broader question, once the markets do stabilize and we start to see retail investors take on more risk I am just curious to get your thoughts on how you see allocations to international equities playing out. Do you think investors will continue to put more of their portfolios in funds investing overseas or do you see more kind of a reversion to mean in terms of historical allocations?
Gregory Johnson
I think it is hard when you say what is the mean and what is historical and the fact is we operate in a global economy and I think people, the acceptance to investing outside of the U.S. is much higher.
The comfort level to that risk is much greater than where it was 5-10 years ago. So I don’t think that has changed.
I think once you see the returns come back and to me it is always a function of what it does against your local market. If global equities do better and that is a function of the dollar as part of that one way or another you will get that share back pretty quickly.
Now the question today that all investors are having on the 40% or so decline in equity values and I think that is very different than anything we have seen before so how quickly they come back and do they come back more into munies or higher quality fixed income securities that remains to be seen. I think on the 401K side we haven’t seen a big change and I haven’t heard of a big change in the industry as far as people sticking to their [knitting] and still adding to their 401K despite having big sell offs.
So I don’t think you are going to go back to some number of 5% or 6% or 8% or whatever the historic number is depending on what audience you are looking at. I still think the trend will be people are investing more than ever and they will continue to increase that portion as a percentage of the portfolio.
Michael Kim – Sandler O’Neill & Partners
I know you touched on this earlier but it seems like visibility on the non-operating side continues to decline. Is there any part of that portfolio that you could potentially hedge just to kind of reduce the volatility we are seeing on a quarter-to-quarter basis?
Gregory Johnson
From time to time we have unique investments. We have hedged them but when you look at it, my comment earlier was that it is pretty representative of our product line and to try to hedge that wouldn’t be very cost effective.
It is something we have looked at over the years. We have some experience with our joint ventures, financing B shares that have [audio interference] in time to hedge the risk of these shares and it is effective but when you expand that to a global scale of our seed investments it really wouldn’t be cost effective and would add to a lot more volatility.
Operator
The next question comes from Craig Siegenthaler – Credit Suisse.
Craig Siegenthaler – Credit Suisse
Can you provide us with an update for your capital management strategy in terms of how you weigh the option of buyback versus acquisitions and also how do you feel about the carry on acquisition pipeline in the U.S. versus some of the attractive markets overseas?
Gregory Johnson
I’ll talk about the capital management. Really no change to the capital management strategy of being opportunistic.
We are a little lighter this quarter given the market volatility but there is kind of really no change. If the market stabilized I would expect us to get back to levels we have seen in the past.
Then weighing them against M&A acquisitions, this is a subjective decision. It is a factor but we have a lot of cash and a lot of financial resources available to us in an M&A transaction so I wouldn’t give it as much weight as perhaps others would.
Kenneth Lewis
I think just overall M&A activity is very hard. I think there will be more deals done next year but in this kind of environment, certainly the last quarter when you are in the middle of the storm and you have the kind of volatility that you have with that said and trying to model out companies and look at what the right level is to purchase that it becomes hard for the buyer and hard for the seller to agree to what is reasonable.
So I think you need the markets to stabilize a little bit. You will always have the forced seller that may have debt issues there like the banks have to do something quickly but I think in our business there is not too many of those situations and I do think when the dust settles a little bit you will see the activity pick up but it is very hard to do those kinds of deals when stocks are moving up or down 10% on any given day.
Craig Siegenthaler – Credit Suisse
On global bond funds, outflow really picked up there. I think you mentioned there was a lower treasury Indian mandate but I missed that.
I just wanted to know what was that mandate termination and also what were flows X that termination positive?
Gregory Johnson
It was really an India cash management account that we have that corporations use similar to a money fund but it does have a floating net asset value so it is included in short-term bond funds. They had some dislocation in that market place and there were a lot of withdrawals and that resulted in a decreased sales number.
I think the net outflows for the quarter in the India accounts even though sales were down about $5 billion, net outflows were down about $500 million and we have about $500 million left in those funds today. The global bond side is a little bit different and that number would have gone into that global bond net gross number that you were looking at but global bond itself like the munies had a tough period there when everybody was running to treasuries.
Although our global bond fund had a positive return for the year and continues to be among the best performers for every period you look at. So it is nothing performance related in either case.
It was really just a case of flight to quality.
Craig Siegenthaler – Credit Suisse
So that Indian mandate was that in the global bond or…
Gregory Johnson
No, it is a separate fund run by our Indian local asset manager for Indian Corporations investing in Indian short-term corporates.
Craig Siegenthaler – Credit Suisse
So it sounded like it was pretty small relative to that level of redemptions. Is that correct?
Gregory Johnson
Yes, it was $600 million out of the total which was $7 billion for that category including munies.
Operator
The next question comes from Kenneth Worthington - JP Morgan.
Kenneth Worthington - JP Morgan
First, I may have just misunderstood you, I think if I heard you correctly the buybacks slowed down because of market volatility. How does that play into your decision the stock was at $100 last quarter, it is $50-60 this quarter, why wouldn’t you increase the buyback?
Gregory Johnson
The first two months of this quarter there was unprecedented stock market volatility and you just didn’t know which way it was going. So that was a factor.
It is usually not a factor in our decision but I think given the exceptional circumstances this quarter we were a little hesitant and slower on the buybacks than you have seen in the past.
Kenneth Worthington - JP Morgan
In terms of compensation, other firms with a December fiscal year end use the fourth quarter to kind of true up given the market weakness. You are a September fiscal year end.
How do you think about December comp? Is it a true up to the calendar year?
Does it become a run rate for the 2009 year? I know you talked about severance and other things but excluding that how do you think about the quarter?
Gregory Johnson
The variable component we have to estimate what we think it is going to be on our fiscal year basis. The September 30.
We are sitting here at the beginning of the year looking at 9 months forward and trying to take a best guess at that. It is a function of profitability.
It is a function of the revenue assumptions you make in the business and budgets and all that. So that is how we do it.
Kenneth Worthington - JP Morgan
So it is really the December quarter you think about it as the first year so there is no real opportunity to true up the calendar year because it is a different fiscal year.
Gregory Johnson
No, it is the same fiscal year. We pay bonuses in October based on the September 30 fiscal year.
Kenneth Worthington - JP Morgan
Lastly, on the strategic side you have got a great balance sheet. You have a lot of cash.
There are some distressed things up there. Is it a good time to go on the offensive?
Is it a good time to be exceptionally conservative given the market conditions? Or is it generally in terms of strategic initiatives is it kind of business as usual?
You are sharing bankers, looking at deals but it is business as usual?
Gregory Johnson
It almost comes back to buying back stock in a volatile market. It is somewhat similar.
We are making a bet at some point and I think size matters a lot. As you can be more strategic and aggressive with a smaller firm in a very volatile market because you are downsizing more limited to the upside over the long term.
I think a bigger deal in a very choppy market I think is more difficult to do as I mentioned before. I do think the opportunity is better than it has been in a long time and it is just the fact that look at the valuations, look at the market caps, look where we are in the market and then you have to weigh that against the long-term outlook for the industry which we still are very positive about.
So I think it is a more probable time for those with strong balance sheets to really add long-term value to the company.
Operator
The next question comes from Jeff Hobson – Stifel Nicolaus.
Jeff Hobson – Stifel Nicolaus
In terms of the institutional clientele, any thoughts on how they will address their challenges in terms of fixed income versus equity versus alternative products? Then in terms of the Waterhouse consolidation I guess your company is probably at the center of the storm in some respects because of your involvement with all of those.
How do you see that playing out for you?
Kenneth Lewis
I’ll start with the second because it is easier than the first one. As I said before, any time that you have consolidation of your distributors it is probably not a good thing as an independent asset manager.
The more the debt is combined the more powerful and more reliant you become on that single relationship. Also I think the net effect is part of the reason that we have been reducing some of the distribution as you will see less advisors out there and that is a natural outcome of the market we have had and so you have to downsize your retail wholesaling force and support the group for that.
That could be 20-25%. Who knows what the market is but in this kind of market I wouldn’t be surprised.
That is something we are thinking about. There is not much I think on the consolidation side that affects our business or how we look at it.
I just think net/net it is never a positive in any business to have more of your assets with less people but with that said we have very good relationships with those people. I don’t think it is a big deal one way or another.
I think the question around institutional clients and returns and would it be [out] and I think that is a very good question and a very difficult question and is one that at the end of the day I think everybody probably has to reduce expectations on returns and certainly the growth of many asset classes that were based on an unusual period whether it is private equity or alternatives and then the more realistic expectations of that going forward. I think the net/net to us is that separate account, the long only strategy now becomes more attractive in this marketplace than it has been in the past and I think with the decrease in the asset values there that you should see increases in reallocations going back into those in the next quarter or so.
Jeff Hobson – Stifel Nicolaus
Just to follow-up on the distribution issue, if we conclude that is kind of a net negative does the other than U.S. business strategically become that much more important or attractive to you?
Gregory Johnson
I don’t think so. Again, you have a mature marketplace here.
One could argue that many of the markets outside the U.S. are more concentrated than the U.S.
as far as distribution with big banks controlling the majority of any mutual fund flow so I don’t think it would affect our thinking one way or another. If it makes one channel or one area more expensive than the other then that is something we are going to build into our long-term plan and how we allocate resources but for today it is just too early.
Operator
The next question comes from Cynthia Mayer – Merrill Lynch.
Cynthia Mayer – Merrill Lynch
A quick question on the income fund. The data I am looking at makes it look like net outflows climaxed in October and I’m just wondering what your outlook is for flows on that fund and if you have seen similar periods of underperformance in the past and in those cases where the flows were kind of lagged…
Kenneth Lewis
I actually used to run that fund many years ago and I can tell you there are two periods of underperformance. It is because of its unique nature and its mix.
It will always have high yield bond and we don’t make scrap calls or credit calls and move into treasuries because the yield is a big part of that fund. So the good news is when you have a fund that is a high yield like the income fund people can gravitate towards that fund based on the yield and its long-term record.
It is not like an equity fund that has to be in the top quartile every period. We always own utilities.
Utilities over the year had a tough year along with corporates and the things that used to not correlate as much. Everything kind of correlated last year so it made it difficult.
The other side is the big fund in that category most of them had exposure to the financials because that was a place you could get yield whether it was through preferred's or through common stocks. So its major competitors have all had similar numbers.
So I think that helps us get back. It is really again, when the markets turn and when financials stabilize and I think that fund will come around.
Because of its high yield it tends to attract assets in just about any market.
Cynthia Mayer – Merrill Lynch
Also you mentioned you really didn’t benefit from the surge in money market flows and I’m just wondering is there any special reason people coming out of bond funds didn’t go into money market funds or is that just a function of your not being in the institutional money market business as much?
Kenneth Lewis
I think if you look at our mix and we did benefit but it is a small portion of our assets. Our sales were up 6-70% quarter-over-quarter for money fund flows but if you look at our mutual funds most of the advisors that sell our funds have sweep accounts their clients can move right into the money funds with their brokered dealer.
So we are not going to get the money that moves to the sideline. We will get a little bit of it and that is why we have funds and they are really there as a convenience.
They are really very conservatively run. We haven’t had any of the credit or liquidity issues that some other funds have had because we have never used them to compete on a yield basis.
I just feel like it is a tough competitive business where there is enough players in it and it is not something we need to be in.
Operator
The next question comes from Matt Snowling – Friedman, Billings, Ramsey & Co.
Matt Snowling – Friedman, Billings, Ramsey & Co.
I just wanted to circle back to the question on the auto portfolio. Can you provide some details in terms of the composition?
FICO, auto type and maybe where you ended the quarter on the residual balances?
Gregory Johnson
It is like 49% prime, 49% non-prime and then the balance below that. Then on the balance itself we have about 130 on balance sheet and I think we are servicing about $700-800 million in past securitizations.
Matt Snowling – Friedman, Billings, Ramsey & Co.
What was the carrying value of the residuals?
Gregory Johnson
I’m sorry, of the residuals, the investment only stripped is down to I think $16 million.
Operator
We have no further questions at this time. I would now like to turn the call back to Mr.
Johnson.
Gregory Johnson
Thank you everyone for attending the call and we hope the next call will have some better news and a more stable environment.
Operator
Ladies and gentlemen this does conclude today’s conference call. You may now disconnect.