Welcome to the Franklin Resources Earnings Conference Call, for the Quarter Ended March 31, 2021. My name is Denise, and I will be your call operator today. As a reminder, this conference is being recorded. And at this time, all participants are in a listen-only mode.

I would like to turn the conference over to your host, Selene Oh, Head of Investor Relations, for Franklin Resources. You may begin..

Good morning and thank you for joining us today to discuss your quarterly results. Statements made on this conference call regarding Franklin Resources Inc., 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 just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the risk factors and the MD&A section of Franklin's most recent Form 10-K and 10-Q filing.

Now I'd like to turn the call over to Jenny Johnson, our President and Chief Executive Officer..

Thank you, Selene. Hello, everyone. And thank you for joining us today to discuss Franklin Templeton's second quarter results. Greg Johnson, our Executive Chairman, Matt Nicholls, our CFO and Adam Spector are Head of Global Distribution, are also on the call with me today. We hope that everyone is well.

We continue to operate our business effectively with over 95% of our employees working from home. Broadly speaking, we're planning for a return to office in September. Though our approach will be flexible and shaped by local requirements and the status of the pandemic in the countries where we do business.

We are encouraged by the number of vaccines that are now being distributed worldwide. The rollout rates obviously vary by country, the progress is very promising. Having said that, we have been deeply concerned by the suffering that has resulted from the surge in cases in India and other parts of the world.

Our thoughts go out to our employees and clients who have been personally impacted by this terrible disease. Turning now to our second fiscal quarter. Today, we are pleased to report financial results that reflect our continued progress with revenue growth and margin expansion, resulting in a 6% increase in adjusted operating income to $581 million.

Our financial flexibility remains strong, with cash and investments of $6.2 billion at March 31, net of $250 million of debt paid down in the quarter. After only two quarters as a combined company, we're experiencing organic growth in a number of key areas.

We're now in more robust and diversified active management business and we're encouraged and excited by our collective potential.

Our merger has created a differentiated global firm, which balances scale and specialization and which we believe offers expanded opportunities for our stockholders, clients and employees as well as the financial professionals with whom we partner.

Turning to performance, we're seeing an improvement in performance across a broad base of investment strategies from the prior quarter. More than two-thirds of our strategy composites outperformed their respective benchmarks for the four key time periods.

And number of our mutual funds rated four or five stars by Morningstar increased to over 140 funds this quarter. Turning next to distribution highlights. We're encouraged by the positive results of our new sales initiatives and efforts to deepen relationships.

More clients purchase both Legacy Franklin Templeton and the Legacy Legg Mason strategies as demonstrated by our merger wins during this quarter. Our expanded distribution efforts drove an increase in gross sales of 32% from the prior quarter across a broad array of funds, vehicles and asset classes, led by U.S. retail.

Long-term inflows increased by $15.9 billion or 19% quarter-over-quarter to $99.4 billion excluding reinvested distribution. Second quarter long-term net outflows improved to $4.2 billion compared to $4.5 billion in the prior quarter. Importantly, if you exclude reinvest in distribution, net outflows improved by over $10 billion.

Our sales momentum continued with positive net flows in the Benefit Street Partners, Clarion Partners, ClearBridge, Fiduciary Trust International, Franklin Equity Group, Franklin Templeton Fixed Income, Martin Currie, Royce and Western Asset. As we said on previous calls, the firm has been focused on expanding our alternatives platform.

And this quarter we did. Alternative strategies grew by $4 billion to $131 billion in assets under management, with contributions from real estate, private credit and retail alternatives. Clarion partners and Benefit Street Partners both reached record AUM levels, and K2 alternative strategies also contributed to positive net flows.

Fixed Income inflows increased by 27% to $53.5 billion from the prior quarter due to positive contributions from a diverse group of fixed income strategies, including core bond, core plus, and corporate. We are pleased that Western Asset experienced net inflows of almost $10 billion in the quarter, its highest level in over a decade.

Equity inflows were $32.4 billion consistent with the prior quarter excluding reinvested distributions. We continue to see strong interest in our thematic equity strategies. And while still early days, we're seeing progress and increased interest in our value strategies.

As of this quarter end, our institutional pipeline has increased with a combined total of one but unfunded mandates of $13 billion, and it's diversified across all asset classes. Aside from our specific results for the quarter, we are also pleased to release our corporate social responsibility report in April.

We establish clear goals and priorities for fiscal year 2021. ESG investing is key among them. And we continue to make important strides to keep our diverse inclusion efforts at the forefront.

Before we open it up to questions, I'd like to thank our outstanding teams around the globe that continue to do extraordinary work every day on behalf of our clients and firm. And they've done so this past year under challenging circumstances. I am grateful for everything they do. Now your questions, operator..

[Operator Instructions]. Your first question comes from Dan Fannon, with Jefferies. Your line is open..

Thanks. Good morning.

My questions on flows and just kind of the momentum if you look at the backlog, which continues to grow, can you talk about the difference in the backlog this quarter versus last? And then also on the strength and alternatives if you could talk about the fundraising if it's evergreen or ongoing or if there was some kind of specific closes that maybe drove business strength in this past quarter?.

Sure. I'll take that. It's Adam here. Thanks for the question. If you think about what's happening now and how flows are changing, the good news is that they're becoming far more diversified, which is actually what we've been planning to do.

So we're seeing good flows, equity fix, alternatives, as well as in our solutions business and geographically diverse as well. The U.S. remains by far the largest driver of flows, but we're seeing very good flows in Europe and the Americas as well. In terms of alternatives, I'd say two things happen there.

At the top end of the market, we saw really healthy subscriptions into Clarion, K2 and others from the institutional market. But we are also really trying to address the democratization of alternatives, and had some very healthy raises for BSP and others in the wires.

And that's something that I think will continue throughout this year as we have other retail launches for other alternative products throughout our system..

Great, thank you..

Thank you. Your next question comes from Brandon Hawkins with UBS. Your line is open..

Hi, good morning. And thank you, this is Adam Beatty in for Brandon. Just want to ask about some of the exchanges from equity into multi asset, it seem like that had a bit of an effect in the quarter.

And just the trend you were seeing throughout the quarter, maybe the trajectory, do you expect a little bit more of that, given where the markets have been? And is there anything in terms of maybe a poll on the multi asset side that, either through marketing or distribution where you're kind of accelerating that movement in some way? Thank you. So.

Sure, let me address that in two parts. First of all, in terms of the exchange, that is more of a one-time thing where we have essentially reclassified and tweaked how we manage an existing funds. So that caused a reclassification. So that's an accurate change for this quarter, but not something that you should see happening quarter-over-quarter.

In terms of solutions in general, though, that has become a focus.

What we see at our largest distribution partners is that there is a focus on having their advisors focus more on asset gathering and less on portfolio management, which means that the management teams that our biggest partners are really looking to firms like Franklin, that our full service offer active sleeves across the entire suite to provide models and solutions.

And that's where we're seeing significant pickup in our solutions business and one imagine that would continue throughout the year..

Great, thanks for broadening the answer. Appreciate it..

Thank you. Your next question comes from Robert Lee with KBW. Your line is open..

Hi, this is Jeff Dresdner [ph] on for Rob. Quick question for in regards to gross sales for fixed income. There's a large step up there. But then there was a bit of a sharper drop in equity gross sales. I wonder if you can provide any color and some of your peers have been showing some more demand on the equity side..

Yes, we're seeing good demand in fixed income and in equity, in fixed income. Western just had an absolutely fabulous quarter. And I think that's what drove a lot of the top line on fixed income.

From an equity standpoint, the great news is that with value coming back in the marketplace from a return perspective, we feel that we are quite well balanced in terms of our exposure to value and growth. The majority of our inflows and equities continue to be on the growth side. And things like Dynatech, ClearBridge is large cap growth.

But we have very strong product on the value side. And we're starting to see a pickup there as well..

Also, if you execute reinvested distributions from the chart, the sales are about flat. And in fact, the net flows improved into equities when you exclude reinvested distributions..

Great. Thanks. And if I could just quickly follow with one more. Just in terms with capital management.

Maybe your thoughts on acquiring additional high net worth businesses, and maybe just a general outlook on the acquisition?.

Yes, I mean. Okay, Jenny, go ahead..

We've stated that we want to continue to grow, Fiduciary Trust, and as we're looking at that those potential acquisitions, we're usually looking not only for assets and expanding our distribution there, but geographic benefit, maybe in a location that we're not located as well as capability.

So as the last two, with Peno [ph] we got really a top ESG Manager and 10 trust with a special needs trust. So it is still an area of focus for us and we will continue to look to acquire there..

Thank you. Your next question comes from Ken Worthington, with JP Morgan, your line is open..

Hi, good morning. The Biden administration has proposed higher dividend and capital gains taxes for the high net worth. If these proposals go through, do you think they could or would have an influence on your business? Either the types of products that are sold or the distribution channels through which they're sold? Thanks..

So, we look at ourselves, as a firm, our expertise is our investment management capability. We want to be flexible in delivering that expertise in whatever vehicle our clients would like to receive it in. So, that can be a mutual fund, that can be an ETF, a CIT, a separately managed account.

So there's no question that there's a lot of discussion out there, that the mutual fund has some tax inefficiencies that an ETF doesn't have, and that there is the potential to see a shift there. However, you were probably already seeing a bit of that shift, as many fee-based advisors prefer the ETF vehicle.

So we want to - if that happens, you're likely to continue to see an acceleration in that shift. What we have been hearing for last couple of years from our distributors is you need to be able to package all of your products in any of these vehicles and be agnostic to it so that you can meet the demands of our varying distribution groups..

And what I would add to that, Jenny is that, we believe we'll see increased demand for our Muni [ph] capabilities, where we have a really strong capability of both Franklin Templeton fixed income, as well as at Western.

And in general, as taxes taken larger bite of the apple, active management becomes more and more important, which we think is in our favor as well..

And Jenny, you mentioned the ETF wrapper, since you guys control presidium? Is that something that you're seeing benefit them in terms of either leads or new business inquiries, any flavor there?.

So I think it's the jury's still out a little bit on whether people want a true kind of blind trust for their active management capabilities. I think there's a view that many of the products it's okay to have some transparency even on the active side. We do certainly, and certainly in fixed income.

But I think there are some you take a small cap strategy; you're going to need to have that in some kind of blind trust and an ETF. So I think that presidium has the opportunity to benefit.

But I don't think that it will be at the level maybe what it was launched, where people thought it would that all active ETFs would be in that kind of packaging for an ETF..

Thank you very much..

Thank you. Your next question comes from Michael Carrier with Bank of America Merrill Lynch, your line is open..

Good morning. This is actually Shawn Kalman [ph] on for Mike.

Can you guys update us on your distribution efforts are placing Legacy Legg Mason products into retail products? And did that have a major impact on the improved gross flows in the quarter?.

Sure. One of the two things that I think we need to be successful is cross selling, the others getting our generalist specialist model.

So from a cross selling perspective, if you take a look at the two organizations, premerger, Franklin had much more of a strength in the regional broker dealer channel lag was a little stronger in the wires, there were some geographic differences as well.

One of our major efforts is to make sure that we take advantage of that complimentary nature of the two businesses. So if you take a look at what's happened so far year-to-date, we've crossed sold to about 5000 new advisors, advisors who either owned only Legacy Franklin and bought Legacy Legg product or vice versa.

And that cross selling is having a pretty significant impact. Another way to look at that geographically, is to think about the presence that say Franklin had in Canada, or the Americas or where was a little lighter. We're now at about 25% ahead of last year sales in those regions for Legacy Legg Mason.

So yes, kind of that cross selling that's had a significant impact..

Thank you..

Thank you. Your next question comes from Alex Blostein with Goldman Sachs, your line is open..

Hi, this is Sherry [ph] filling in for Alex. My question is on the expense guide. In the commentary you mentioned as to subject to market conditions. So just wanted to get a sense as to what are the market assumptions and flows estimates that you have taken into consideration for the rest of the year..

So in terms of the market, we're assuming a flat market, we don't make any additional market overlay assumptions in our guidance. In terms of the flow trajectory, we're assuming something similar to what we've been experiencing and the improvements that we've been experiencing over the last two quarters.

So that's why our guidance remains consistent with what we described last quarter. What's pushed it up slightly in terms of the we mentioned $3.75 billion to $3.8 billion for adjusted expenses was push that up slightly as is the obviously the continued momentum in the market.

But also our performance has improved our flow to improve and our results have improved. So by definition that does have an upward pressure on compensation in particular, but we have other offsets in our cost structure on in that regard..

Understood, just to follow-up on that.

So assuming that this flow territory and the markets continue to grind higher, what's the sensitivity of this guide kind of go up for the rest of the year?.

I think we fit for the third quarter we feel good about the continued 3.75 to 3.8. We're provide further guidance for the fourth quarter and 2022 when we reach that point..

Got it, thank you so much..

Thank you..

Thank you. Your next question comes from Brian Bedell with Deutsche Bank. Your line is open..

Great, thanks. Good morning, folks. Just wanted to talk about the fixed income business broadly, obviously, when we get, when we tend to have a backup and yields were rising long-term yield environment. On retail bond funds, that tends to cause at least a temporary downdraft or a spike up and redemption sometimes as the NAV, the NAVs get hit on that.

But, can you talk about, for the institutional side, it can be a different dynamic.

So can you talk about what clients are saying about that or what are their concerns about that, or what you perceive as client demand, if we do have a spike up in yield for Western? Would you see a temporary sort of elevated redemptions on that? Or do you think that's actually positive for long-term?.

I mean, in particular on the institutional side, I mean, let's face it, pensions, insurance companies, they need fixed income as part of our portfolio, both from a cash flow perspective, as well potentially dampen volatility.

So, we have about 43% of our AUM and fixed income, and there are multiple fixed income franchises within Franklin Templeton, and they all manage differently. So we go anywhere from treasuries, obviously, the private credit with a BSP. So they all manage differently.

With a rising rate environment, obviously, you're going to have an impact on the duration component of the fixed income portfolio. But if you take Western, for example, only 4% of their AUM is actually in government bonds. So, the rest of it they're doing, they're managing across sectors, bank loan, high yield, emerging markets.

And if you have a rising rate environment, chances are that's a better economy, economic environment, and chances are those the credit component and the sector component outperform.

So when you look at, we actually did a study at Western and look back to 2000, and there were 30 times where you had a significant short term, or a significant period of rate increase, which defined by greater than 15 basis points in a month and was extended, and in that Western tended to underperform in the short term, but then significantly outperform in six, nine and 12 months, because what ended up and that's versus obviously, benchmark and peers, and that's because the credit sector component kicked in on the performance.

So institutional clients understand that and are willing to kind of work through at least that's been our experience..

And the other thing I would add is that as rates rise, we would expect to see some money coming out of lower fee cash and very ultra-short products into more core products, which will have a positive impact for us..

That's great.

If I can sneak in another one on those the Schwab Advisor engine platform integration with Schwab Advisors, that you mentioned, any view on how that might impact the sales trend through the Schwab Advisor network going forward from where it's been?.

Our strategy is to - as the world has moved on the on the retail side to more of a fee-based environment with somewhere between 75 about 75% flows kind of go in that direction. It has pushed because there's obviously transparencies and what the client is paying the advisor, push the advisor to be more of a wealth manager.

So our goal is to provide additional tools beyond just investment capabilities to help that advisor be a wealth manager deepens the relationship to that.

So in the case of advisor engine, there are tools within advisor engine, and it may be as simple as the CRM system juncture that an advisor that's sitting on the Schwab platform, and gusting on the Schwab platform may want to use some of those tools for some of the clients or all their clients, and they won't use it unless you have integrated to the custody level.

So, it remains to be seen how that plays out. But that's essentially, our goal is to just make it as easy for a financial advisor to do business with us, and to provide those additional types of services.

That for example, like go which ends up providing goals-based investment models, so that you deepen the relationships and hopefully stick your assets with the advisors..

It's great color. Thank you..

Thank you. Your next question comes from Patrick Davitt with Autonomous Research, your line is open..

The last few, you answered all my questions. Thank you. I'm good..

Your next question comes from Craig Siegenthaler with Credit Suisse. Your line is open..

Hi, good morning, everyone. And thank you for taking my questions. This is actually Kareem Afifi [ph] filling in for Craig. My first question is on flows. I was wondering if you could expand on the reason behind the $6 billion fixed income institutional redemption.

Was it performance related, or did the client want to move the money in house? And also, does this particular client have other mandates with Franklin Templeton? Thank you..

Why clients make particular moves, I think you never quite know. I would say, in general, with some large sovereign institutions, we do see a trend to in-source some places, I think this was just not the right mandate for them at the right time. That client still does have significant assets with us as an institution.

And we feel solid with the overall relationship, we just happen to lose one piece of the overall relationship there, a lot of money, but only a portion of our overall relationship..

Got it? Thank you very much. And if I could sneak one more, can you maybe comment on the sustainability of retail flows, given the large government stimulus and strong equity market, which may be making current activity levels unsustainable..

I can only tell you what we're doing, not what the government is going to do from a stimulus policy. And I'm feeling really confident about what we're doing in sales. We post-merger really brought the best of the two firms together; we feel really confident in the field force we have out there.

We've got folks in new territories now for six months, we're seeing the results of that interaction. We've put a specialist generalist model in place. And I see no abatement in terms of the activity we're having the level of engagement we're having, and feel really, really good about where we are from flows.

If you look at us retail, it's by far the largest segment of our overall business. It's the place we've put the most attention, post-merger to make sure we get the integration, right. And we're seeing huge benefits from it. So I'm feeling pretty good about the future..

Thank you very much..

Thank you. Your next question comes from Michael Cyprus with Morgan Stanley, your line is open..

Good morning. This is Stephanie [ph] filling in for Mike.

My question is around the fee rate, given the improvement in performance fees this quarter, do you think the outlook for generating performance fees has improved into the rest of the year? And then just any help on how we should think about the fee rate exiting the quarter and trending from here?.

I mean, look, the fee rate this quarter was supported by a couple of quite large low fee redemptions, we had growth in alternatives, we had good support in equities.

So it's solidified, where the current rate is, we feel quite good for the year to say that the high end of our guidance at 38 basis points, potentially 38 to 39 basis points, is the right way to model that for the entire year..

Great, thank you. And then just one quick one on cryptocurrencies. Do you see a commercial opportunity in crypto? If so, how are you approaching the opportunity from types of products or investments that you might be considering? Thank you..

So I'm not a not a huge fan of things like Bitcoin, because I think over time, government crypto got so big, governments would want to step in and regulate because they like to control their currency. So I'll put that sort of out there first.

That is not to be confused with tokenization, both of assets because I think that that will unlock illiquid assets that become interesting and also tokenized coins that help facilitate business models. And that's different there's nothing backing a Bitcoin but there is something backing a coin that actually has a functional capabilities.

So I think there's a lot of education that's going to happened out there around tokenization.

And I do think that blockchain will completely change sort of how this how our industry how the financial services industry operates their back office, I think it has, as I said, has the real capability of democratizing illiquid assets, that some would argue might even take some of the premium out of alternative space over a long period of time.

But that that would be my answer to that question..

I just add one of the things on the wealth side, having the capability to field let's call it digital assets in general, is going to probably be important for the future. So we are focused on the capability front in that regard..

Great, very helpful. Thank you..

[Operator Instructions] Your next question comes from Brian Bedell with Deutsche Bank, your line is open..

Great, thanks for taking my follow-up. It's on ESG, you have been some detail in the commentary on that. Just wanted to see if you're able to assess what the flows were into ESG dedicated products, or what you call a specific focus for the quarter, and then the $175 billion that you mentioned, with specific focus.

Just wanted to cool in on that a little bit. I think like Mason's if I'm not mistaken is the bigger part of that. Not sure, if you can go into some color on some of the bigger parts of that 175 that you're including in that, that doesn't include any exclusionary product, for example..

So let me give you my little spiel on ESG, why Adam looks up a little more detail on the actual flows, in some of those. So first of all, we would you know, 93% of our AUM has ESG factors.

And when we think it's here to stay, we don't think anybody could be an active manager, without ESG and all of our investment teams incorporate ESG factors into their investment process. And we think that one of the reasons we're so far along in that is one as an active manager, we think that the data out there is not particularly good.

And it requires engagement by investment teams with companies to actually gather the data. And number two, having a large presence in both Europe and Australia, where really these trends kind of started, we had to develop these products way before they became really important in the U.S.

And we think that again, despite the industry coalescing around things like SASB and TCFD, right now, it really requires engagement of an active manager to do true ESG kind of screening. When you look at Europe, they have something called Article six, Article eight and Article nine, Article six as you do the screen.

So our 93% of our AUM would qualify in that. In article eight, we have 25 products there and article eight is sort have a tilt towards ESG factors and Article nine is really impacting its eight funds there. We are seeing good flows into our two Paris aligned climate ETFs.

Our European total return and our Templeton global climate are both reaching a billion dollars, good flows into our social infrastructure fund, ClearBridge, U.S. Equity sustainability fund has been in net sales for the last 12 months. So that's a little bit of your question, we're seeing flows in a broad set of products.

And what's interesting, I think you're seeing is this supply side of ESG is really increasing, as you hear like Europe, one-third of their COVID relief fund will go into green bonds, which is doubling the size of the market, obviously, with the Biden infrastructure. That gets passed, you're going to see increase there.

And so it'll be a lot more supply, which will continue to drive this. And Adam, I don't know if you want to add any additional details to that..

I think Jenny, you hit on all the high points, I would just say that the great thing about our ESG capabilities is that yes, we have it in the traditional asset classes, equities, fixed incomes, but also in solutions and alternatives. And in alternatives in places like K2, Clarion, et cetera, where we're also seeing significant flows.

And I think that combination of ESG and also is going to be a real winner for us..

That's super helpful. In fact, if I just back out the one-time redemption of the 6 billion in the MDA funds, we would have about $3 billion of positive flows for the quarter.

It is fair to say, ESG funds would have driven on a net basis, significant portion of that, positive three?.

I don't think we know the answer to that. But you're right on 3.4, though..

Okay. Great, thank you..

Okay, thank you. That ends our Q&A session; I would like to hand the call back over to Jenny Johnson, Franklin's President and CEO for final comments..

Thank you, everybody, for participating in today's call. Through the work that we've done over the past year, we built a really truly differentiated investment firm, and our progress highlights why we are more confident than ever about our future.

Once again, I'd like to thank all our employees for their significant efforts, dedication and client focus. And we look forward to speaking with all of you again next quarter. So thank you, everybody..

This concludes today's conference call. You may now disconnect..