Aug 4, 2015
Executives
Tina Madon - Managing Director and Head of Investor Relations Daniel Och - Chief Executive Officer and Chairman Joel Frank - Chief Financial Officer
Analysts
Bill Katz - Citi Robert Lee - KBW Gerald O’Hara - Jefferies Craig Siegenthaler - Credit Suisse Michael Carrier - Bank of America Ken Worthington - JPMorgan
Operator
Good morning, everybody, and welcome to the Och-Ziff Capital Management Group's 2015 Second Quarter Earnings Conference Call. My name is Sue, and I will be your operator for today.
[Operator Instructions] I'd now like to turn the call over to Tina Madon, Head of Investor Relations at Och-Ziff. Please proceed.
Tina Madon
Thanks, Sue. Good morning, everyone.
And welcome to our call. Joining me today are Dan Och, our Chairman and CEO; and Joel Frank, our CFO.
As a reminder, today's call may include forward-looking statements, many of which are inherently uncertain and outside of our control. Och-Ziff's actual results may differ, possibly materially, from those indicated in these forward-looking statements.
Please see our 2015 first quarter 10-Q and the press release we issued earlier today for a description of the risk factors that could affect our financial results and our business and other matters related to the forward-looking statements. The company doesn’t undertake any obligation to update publicly any forward-looking statements.
During today's call, we'll be referring to economic income, distributable earnings and other financial measures that are not prepared in accordance with U.S. GAAP.
Information about and reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available in our earnings release, which is posted on our website. No statements made during this call should be construed as an offer to purchase shares of the company or any interest in any Och-Ziff fund.
With that, I'll now turn the call over to Dan.
Daniel Och
Thanks, Tina. Good morning, everyone and thank you for joining us today.
During the second quarter our funds performed well, capping a strong first half and we are extremely pleased with our performance across all asset classes this year. During the quarter we further diversified our business mix and made progress with the development of new product offerings.
In our experience, LPs are migrating to alternative managers who have not only demonstrated consistent performance, but who can also offer products and investment expertise in the range of asset classes outside of the traditional alternative allocation. This select group of managers of which we believe we are one has the size, scale and brand that enable them to identify and capitalize on emerging opportunities globally.
While we have experienced net outflows year-to-date, we do not believe that current flow trends are reflective of the future growth potential of our business. We believe we have built a significant competitive advantage in each of our strategies which in turn have enabled us to diversify our business and build scale in these areas in a short time period as we have done with our credit business.
Additionally areas of the credit market, such as European CLOs and private real estate credit represent opportunities we can take advantage of due to the investment expertise we have built, the synergies between our teams and the scalability of our business. The strength of our investing capabilities is also enabling us to consider adding to existing product offerings, such as UCITS, as well as asset classes, we have demonstrated a strong investment capability over a number of years such as energy.
We believe that our ability to expand our business by building on our inherent competitive strengths is attractive to LPs. This is been demonstrated by LP interest and our real estate credit and energy strategies.
In the last 3 years, our assets from products, other than a multi-strategy funds have increased more than 5 fold to $15 billion as of June 30th. However, we believe that we are just in the beginning stages of the growth that will result from the diversification of our business and a resulting effect this will have on our AUM and earnings.
With that, let me briefly review our products. At the end of the second quarter, the AUM and our multi-strategy funds totaled $33 billion, decreasing 3% year-over-year.
The OZ Master Fund has performed well this year. Through June 30th, it is generated a net return of 4.1% and extended that performance last month ending July with a year-to-date return of 4.8%.
The majority of this performance has been driven by a long short equity strategy, reflecting the strength of our global equity's team. This positioning is not an expression of a particularly strong deal on a direction of global equity markets.
As we believe that equities in total are generally fairly valued, rather reflects our conviction in the individual investments in our portfolio, to relatively large number of opportunities that we are seeing and our view that the current investment environment is conducive to the stock picking. It also demonstrates the value of our active risk management, which gives us the ability to change exposures rapidly.
We believe our investment performance continues to position us, as a leading manager for multi-strategy absolute return products. Separately, we are excited about the opportunities we are seeing in Asia, particularly in China, Japan and India.
We believe the ongoing expansion of regional capital markets, specifically the liberalization of the financial markets in China will create compelling stock tick in capital market opportunities amid significant volatility in the years ahead. Volatility in Asia is a concern for less experienced investors in the region with a deep bench of local investment professionals and over 14 years of on-ground investing experience, we believe we are well position to take advantage of the opportunities volatility creates.
Our investment performance in Asia this year reflects these competitive advantages as we - and we believe these dynamics should result in attractive investment opportunities, as well as growth in our Asian platform. The AUM and our dedicated credit products totaled $11.7 billion at the end of the second quarter, increasing 29% year-over-year.
The assets in our opportunistic credit funds totaled $5.1 billion, increasing 2% year-over-year. Of this amount, the OZ Credit Opportunities Master Fund, our global opportunistic credit fund totaled $1.6 billion, increasing 59% year-over-year.
It generated a net return of 1.1% year-to-date through June 30th and an annualized net return of 15.7% since inception. In recent months, credit market suffered due to drop in the commodities and energy prices, resulting in steep losses in many high yield and similar credit instruments.
We were patient investors in this downturn and are pleased with the performance of our credit funds given challenging market conditions. We are beginning to see positive opportunity emerge in certain areas, specifically in energy and believe our patience will be rewarded with compelling opportunistic investments in the near term.
Our closed-end opportunistic credit funds performed well, with gross IRRs of 18.6% to 24% since inception and gross MOIC of 1.4 to 2.1 times. The assets in these funds declined by $665 million year-over-year, resulting from distributions made during their harvest periods.
The assets of our Institutional Credit Strategies platform totaled $6.6 billion at the end of the quarter, increasing 63% year-over-year. This growth was driven by our CLO business.
In the last 12 months, we have closed 4 CLOs adding approximately $2.1 billion of additional fee-generating capital to our asset base. As part of our expansion, the ICS platform introduced an open-ended loan fund during the quarter.
This fund is another example of how we are taking advantage of our expertise in the credit markets. The assets in our real estate funds totaled $2 billion at the end of the quarter, increasing 9% year-over-year.
We have begun to invest our third opportunistic real estate fund, while our second funds are in the harvest periods, having delivered significant value to the LPs invested in them. They have generated strong returns with gross IRRs of 25.1, 36.1% and gross MOIC of 1.7 to two times on total invested capital.
We continue to broaden the scope of our real estate investing activities taking advantage of synergies between our real estate and other investing teams. The real estate credit fund we introduced in the first quarter of this year was an example of that.
We are also evaluating investment opportunities outside of the U.S, and our real estate team is working closely with our credit and equities teams to identify new investments. We believe that over time this will drive growth not only in our opportunistic real estate business, but also enable us to introduce innovative new products with the benefit of our LPs.
With that, let me now turn the call over to Joel, who will take you through our financial results.
Joel Frank
Thanks, Dan. For the 2015 second quarter, we reported GAAP net income of $5 million, or $0.03 per basic and diluted Class A share.
The press release we issued this morning contains a full discussion of our GAAP results and is available on our website. On an economic income basis, our second quarter distributable earnings were $95 million or $0.18 per adjusted Class A share and our dividend was $0.14.
Now turning to the details of our economic income results. Our total revenue for the 2015 second quarter were $199 million, declining 13% from the first quarter.
Management fees were $167 million, a slight increase from the first quarter, as our average assets under management grew. Our average management fee for the second quarter was 1.42%.
Incentive income totaled $32 million, resulting from crystallized incentive on longer term AUM, as well as from redemptions. The decline in incentive income compared to the first quarter of this year was primarily due to the tax distributions we took in the first quarter that were not repeated in the second quarter.
Now for a brief recap of our economic income operating expenses. Our 2015 second quarter comp and benefits expense was $33 million.
Of this amount, salaries and benefits were $28 million essentially unchanged compared to the first quarter of this year. The remaining $5 million was bonus expense.
Salaries and benefits were 17% of management fees in the second quarter. For the third quarter, we anticipate this ratio will remain in the range of 17% to 19%.
Our 2015 second quarter non-comp expenses were $51 million, 26% higher on a sequential basis. This increase was primarily due to the higher expenses related to legal and regulatory matters.
Non-comp expenses were 30% of management fees in the second quarter. For the third quarter, we expect this ratio will increase to a range of 35% to 37% due to the increased legal expenses relating to the ongoing FCPA investigation.
However, we continue to remain hopeful that this increase will normalize by the end of this year. Our effective tax rate for the 2015 second quarter was 17%.
For the third quarter and full year, we estimate that our effective tax rate will be in the range of 17% to 20%. In closing, I’d like to reemphasize the importance of the diversification of our business to the growth and assets under management and in turn earnings.
As Dan mentioned, the diversification of our business is increasing rapidly with about third of our assets under management investment and products other than our multi-strategy funds. The breadth and depth of our investment teams in each of our strategies has been essential to the success we have had to date in diversifying our business, not only in establishing our presence as a manager who dedicated credit, real estate and equity products, but in building scale as we’ve done in credit.
Because we are a leader - leading alternative manager, we continually see a broad range of investment ideas globally. This allows us to identify and capitalize on emerging trends and build new investment platforms around them creating value for our LPs.
As a market for alternative products rose in areas that have traditionally not been open to us, such as core, fixed income or equity is driving significant incremental demand. This is a secular trend we believe will not only increase industry capital allocations, but also influence which managers will be leading beneficiary.
We believe the long-term growth potential for our business is substantial. Our business has size, scalability, global presence and investment expertise to meet the growing demand for our existing products and innovative new one as investors demand evolves.
These attributes are sustainable, competitive advantages that will continue to differentiate our business across our platforms and drive asset growth. As our assets grow and our business diversifies further, we expect that growth and consistency in our revenue earnings will increase.
With that, we will now take your questions.
Operator
[Operator Instructions] Your first question comes from the line of Bill Katz from Citi. Please proceed.
Bill Katz
Okay. Thank you.
Good morning, everyone. I appreciate you taking the questions.
Just wanted to sort of counterbalance your commentary of feeling good about growing the business from here versus some of the real-time trends. When I look at the Master Fund, you've had outflows now for four quarters in a row.
Sort of wondering can you sort of talk through what some of the drivers of the attrition has been? Obviously, performance is pretty good year to date, but nonetheless how much of it is related to, maybe just asked differently, can you sort of talk to the breadth and depth of where the attrition is coming from?
Daniel Och
Sure. I mean, look, we found historically flows in all our products tend to be episodic and the key is you’ve seen over 20 years and since we've been public and we generate performance and manage risk and do all the other thing that we always talk about.
Then we established and maintain our position as market leaders both in the individual products and with institutions and other investors overall and we're very confident that that is going to continue. The performance in the Master Fund continues to be strong.
We think it’s providing what clients are looking for. They are getting a deeper and deeper knowledge of what we do and how we do things.
If you look our - credit products, our credit and other products have grown fivefold over the past several years. We think we’ve got a lot of room there as well.
So, we think that if we can continue to maintain performance and other capabilities than our multi-strategy products will maintain the market leader positions, while we grow other products. And exactly how that growth ebbs and flows, it’s hard to predict.
Bill Katz
Okay. Just a follow-up question, you mentioned China, India and a few other areas as sort of big areas of growth.
China seems to be some controls being put in place by the government there. How much exposure do you have to Mainland China?
I think one of your peers recently was sort of shut, at least temporarily, and is that having an effect on your ability to drive performance in that region?
Daniel Och
Look you’ve seen the performance both in - July was the difficult time period in China. You can see the performance in the multi-strategy fund was positive, you can see the Asia Fund did get back to some part of its profit.
But we think risk was actively managed there, well there. We've been in Asia for 15 years now.
And we’ve seen all number of different cycles. We've seen a lot of firms come, go, come and go again and come and go again during that 15 years.
We've got over 40 people on the ground. We think we have the market leading presence and capability.
We think that these are very large countries, with very large economies, with a lot of growth and change in front of them and being on the cusp of that is we think is going too well - work well for our clients.
Bill Katz
Okay. Thank you.
Operator
Thank you. And your next question comes from the line of Robert Lee from KBW.
Robert Lee
Thanks and good morning. I guess maybe first question, just kind of curious on the kind of distribution payout ratio.
I mean historically you've run kind of 90% plus in terms of your distribution versus the DE. This quarter I think it's around 75%, 76%.
I mean, was there - can you maybe talk about that a little bit and should we expect that maybe in subsequent quarters you have to go back to kind of the historic payout ratio or is there something going on that may keep it at a little lower level for a while?
Daniel Och
No, look I think Rob, it’s generally the same reasons we have had before, whether it’s RSUs settlements, CapEx, taxes, again I think you’ll see it range - the range will vary you know as we go across quarters. But I think you know this range to a little bit a higher range as what you should expect across the board.
Robert Lee
Okay. And then I'm just kind of curious in terms of from a fund raising perspective, and I know you can't comment on specific accounts, but I guess it's been public.
State of New Jersey has committed more money, but I think it's also public knowledge that they get somewhat of a fee holiday. I guess, for a period of time and some new capital, I guess.
I guess my question is if you have committed capital that hasn't yet started earning fees I assume that's on your AUM, is it possible to kind of quantify that kind of dry powder so to speak that has already been committed to you guys but hasn't yet shown up in the asset levels?
Daniel Och
No, look we're not going to talk about specific investors and specific flows. I mean, you did see that they - there is commitment.
And whenever we could obviously we would, but we're not going to talk about specifics.
Robert Lee
Okay. Let's see, what else.
I guess, a follow-up question is over the last several years business has kind of seen some shift in your client base towards, I think, more pensions, more institutions. I don't have the various figures right in front of me.
And I'm just kind of curious, I mean, how has that impacted the sales process to the extend, maybe consultants get more involved in the process and maybe - and I don't know to what extent maybe that because of some of the ongoing investigations that's kind of slowed the new sales process. But I'm just kind of curious how maybe the dynamics have changed as the client base has shifted and if actually the consultants are kind of more involved because of that?
Daniel Och
Well, every client base has its unique feature, at the end of the day out goal to have the best product and capabilities, figure out where the opportunities are going to be, design the process to fit those clients. So you are correct, over the past several years our focus has been on private banks and on pension funds, primarily because we thought that was where the best opportunity was.
And you've seen large increases in both areas, because we had the products and capabilities and we executed the sales process properly. Going forward, in addition to those areas, we think there are some new areas and channels that will exist for us.
And we're taking the same approach, have the best products, have the capabilities, think about how the channel works or how the clients work and accommodate that. I mean, the - our growth with private banks and pension funds has not only been the multi strategy front, but it’s also been with our other products.
And so we think that having all the teams work together, the products, the sales force, the other parts of the organization is what clients are looking for and it works well.
Robert Lee
Great. I appreciate your patience with my questions.
Just one more quick one. You had mentioned - I guess you had launched an open-end fund.
And I think I missed the last part of it, was that a pay loan fund, bank loan fund and can you maybe just update us what channels that's being distributed through?
Daniel Och
It's an institutional credit fund, and it's through our - we distributed through our normal channels, nothing unusual.
Robert Lee
Okay. Great.
Thank you for taking my questions.
Daniel Och
Thank you.
Operator
Thank you. And your next question comes from the line of Gerald O’Hara from Jefferies.
Please proceed.
Gerald O’Hara
Good morning. Thanks for taking our questions.
First, it's clear that product diversification strategy is well underway, but it also appears then the multi-strategy outflows are edging out newer product inflows. Can you maybe give us a sense at how mainly discussions are progressing with some of the quote-unquote early inning products?
I mean, which you are seeing the most traction with or which kind of have the most opportunistic outlook for?
Daniel Och
Well, we have a number of different things going on and it's sometimes hard to predict exactly how they are going to play out. You saw there was an announcement made several months ago by BDC that we're going to sub-advising on.
We talked about real-estate credit and some of the other things that we may do there. We talked about energy.
In addition some of the more establish new products, such as the institutional credit side, we have a lot to do there. So CLO's clearly have been growing well very.
Joel just mentioned the long fund which is something relatively new. So while it's hard to predict.
We are going to do our best to post to your number one of what the new products and initiatives are. And then as they grow and develop, as a general matter as they grow and develop and the assets become more relevant we will post you accordingly.
Gerald O’Hara
Okay. That’s helpful.
Daniel Och
I think the key is more - more irons in the fire, more opportunities for growth, more areas where we think we can demonstrate that we excel. And you saw that at the beginning of this year, on the fourth quarter earning call when we released the credit and real estate returns historically.
I think that - for those who hadn't been exposed top them on a consistent basis, was very clear that the performance was very, very strong, very consistent to a lot of different cycles. And our view is that we can continue to show that in different areas, we're going to continue to do well in terms of the new product.
Joel Frank
And I'll add even on a new product front and all those different things that we're doing, it's not just throwing something against the wall and see what works. We - there is investor interest in all of them and that’s one reason why we are developing them in accordance with what expertise we have.
So hope that's helpful.
Gerald O’Hara
Yes, absolutely. Thank you.
And just as a follow-up, as it relates to the ongoing legal investigation. I understand you - probably can't give much details here if anything at all really.
But is there any color at this point, probably a question for Joel with respect to any potential future non-comp legal accruals? And actually just sort of a tie-on here, I suppose this is a topic that's been coming up in client discussions for a potential mandates?
Thank you.
Joel Frank
Well, first in terms of the investigation, at different progression points, so that's going to affect expenses. But we're hopeful that the effect to non-comp will moderate by the end of the year.
We're hopeful the investigations is over by the end of the year. But it’s something that I can't predict.
In terms of conversation with investors, yes, of course it’s going to be something I would discuss, but it’s not a major focal point.
Gerald O’Hara
Great. Thank you for that.
Operator
Thank you. And your next question comes from the line of Craig Siegenthaler from Credit Suisse.
Please go ahead.
Craig Siegenthaler
Thank you. Good morning.
First just coming back to net flows, were there any large redemptions in the negative $1.1 billion of flows in the multi-strategy funds?
Daniel Och
I am sorry, could you ask it again, I am sorry, I didn't hear it.
Craig Siegenthaler
Any unusually large redemptions, I wonder if you could call out maybe the one or two largest redemptions in there or was it spread across a wide base of clients?
Daniel Och
Yes, it’s a spread across a wide base of clients.
Craig Siegenthaler
Got you. And then third quarter performance fees always have that seasonal step-up, can you help us with what we should be expecting for the 3Q, '15?
Daniel Och
I am sorry again; I didn't hear what you said?
Craig Siegenthaler
During the third quarter you typically have a step-up in performance fees, pretty large in last two years. I'm wondering if you could help us with your expectations for the third quarter.
Daniel Och
Look, it’s not necessarily third quarter, that's going - the first three quarters are going a very based on what we crystallized in terms of longer term assets and redemptions and such. But the fourth quarter is one we collect the majority of incentive.
So I will give you guidance when I can on specific items that I know are going to comment, in terms of the third quarter at the moment there really not much guidance I can give you.
Craig Siegenthaler
Okay. If returns this year is shaping up to be similar last year and the asset base is somewhat similar, could it be pretty close to last year?
Daniel Och
I mean it could be, but I can't project because we don’t know what performance is going to be through the end of the year and of course we don't know the asset levels at the end of the year. So it’s very hard to project and it’s something I wouldn't predict.
Actually what you do is follow the returns that you see so far year-to-date, you can make some assumptions if you would like to do that through the end of the year, but we can’t predict returns
Craig Siegenthaler
Got it. And just one last one here on OZ Master.
Equity long, short, you've seen the highlight that it's the major driver of positive performance recently. What were the major drivers against that, what were weighed on that return?
Daniel Och
Well, we're not going to be weight out we were generally positive in all investment areas. But the largest allocation was to the equity long, short, and as a general matter of the best performance was in the equity long, short.
Craig Siegenthaler
Got it. Thanks for taking my questions.
Operator
Thank you. And your next question comes from the line of Michael Carrier, Bank of America.
Please proceed.
Michael Carrier
Hey, thanks a lot. Just another question, just on the outflows, I guess, overall, but focused on a multi-strat.
I know you said over the years you had periods where you had these episodic times where you do have outflows. Just wanted to get a sense like when you go through those periods, what typically has been the driver and I think we've seen with some firms in the industry where they made - really successful in bringing in money in a period of time and then you go through a period where in that region or that segment of the market you see redemptions for a period of time just because they were actually very successful and then you see some of the reallocations going on.
So just wanted to get any sense of if that's part of the driver, if there's any capacity issues because it just seems - it does seem strange given the performance versus the industry in seeing good consecutive quarters where you are seeing outflows?
Daniel Och
Well, it can be a number of different factors and I think what's key for us is we believe very strongly given the performance in those products in particular that all the issues relate to the category itself, whether it’s a multi-strat or however the category is grouped. So, what we’ve seen - I believe your question was kind of what the factors are and may be what turns it.
We never know what turns it. Having said that, historically we’ve always seen that as long as we’re performing and we’re doing the right things it has always turn and we’re very confident that it will turn again.
Michael Carrier
Okay. And then just a follow-up, some of the newer areas where you're diversifying, just wanted to get an update on the outlook when you see, when you think about the funds that are in the market, what the fund raising potential is.
And then I think from a shareholder's standpoint when we think about the economics typically a lot of the growth has been coming from like the CLO side. Just wanted to get an outlook on that in terms of the fees and how we should be thinking about that coming down to distributable earnings.
I guess my point is in some of these products are you at scale or does the increasing scale continue to benefit the overall operating leverage in the business and margin?
Daniel Och
The product themselves, both the overall category, we think there is a substantial amount of growth, on the individual products, we feel the same way. So on the credit side, on the real estate side in some of the areas, we mentioned here on the call, while we’re pleased with a fivefold growth over the past several years.
We think that we’re at the beginning stages of that expansion and that capability. As a general manger we feel the same way, the different products that we mentioned that were up.
We’ve recently announced whether it’s the loan fund, the real estate credit opportunities, some of the others, we think there is big potential there.
Joel Frank
In terms of the economics, I mean obviously it’s hard for us to predict, but I think the easiest way obviously to model is using the overall AUM and the average management fee. And our concern is not, hey you know what, this product has a lower fee than other products.
This is additive to our AUM and to our investment process. That’s a big positive to us because it generates revenue and the majority of our products they paid have a 20% incentive fees.
So it gives us the opportunity to earn a considerable amount of incentive income.
Michael Carrier
Okay. Thanks a lot.
Operator
Thank you. And your next question comes from the line of Ken Worthington from JPMorgan.
Please proceed.
William Cuddy
Good morning. This is Will Cuddy going in for Ken.
Our questions are already asked and answered. Thank you.
Joel Frank
Thank you.
Operator
Thank you. And your next question comes from the line of Will Katz from Citi.
Please proceed.
Will Katz
Okay. Thanks for taking my follow-up.
Just two of them. Joel, you mentioned that you hope that the elevated G&A might dissipate by the end of the year.
Does that mean that the fourth quarter is most likely to be elevated as well or would the fourth quarter potentially be lower than the third quarter?
Joel Frank
Well we’re seeing - again it’s a process I can’t predict and I’ll give you guidance like I always do, but if something if it’s going to be lower or the same or whatever we'll when we get to that point, you’ll know in advance.
Will Katz
Okay. And then just a follow-up.
In terms of the change, not change but the payout of the distribution - dividend, how much of that relates to potentially some legal uncertainty or capital that's necessary for building up some of these newer products versus just a change in policy?
Daniel Och
None of it relates to any legal uncertainty. Some of it - I think the real answer and is focusing on this stuff is, if we think there is value in retaining of some of the - to see some of our products which we do, in other words if it’s retention of capital for different products we're going to do that.
If we think that’s some value, we're going to do that. But we are going to discuss it and you'll get a sense of it.
So, there is some investments we're making in certain products. As an example it could be CLOs, it could be other stuff we're doing.
But you're going to get a sense over time whether we think it’s more valuable to retain that cash to invest in products or distribute it. But in general I think we're going to remain around this level for a while, if that’s going to change, obviously we’ll talk about it with you.
Will Katz
Okay. That’s helpful.
Thanks for the clarity.
Operator
Thank you for your question. That concludes the question-and-answer session for today.
I will now turn the call over to Ms. Madon.
Tina Madon
Thank you and thank everyone for joining us today and for your interest in Och-Ziff. If you have any questions, please don’t hesitate to give me a call at 212-719-7381, media inquiry should be directed to Jonathan Gasthalter at 212-687-8080.
Operator
Thank you, for your today’s participation in this conference. That concludes the presentation.
You may now disconnect. Have a very good day.