Virtus Investment Partners, Inc. Stock

Good morning. My name is Jacinda and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website at www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. [Operator Instructions]

I will now turn the conference to your host, Sean Rourke.

Thanks, Jacinda and good morning, everyone. Welcome to Virtus Investment Partners discussion of our second quarter 2026 financial and operating results. Joining me today are George Aylward, our President and CEO; and Mike Angerthal, our Chief Financial Officer. After their prepared remarks, we will open the call for questions. Before we begin, I'll refer you to the disclosures on Slide 2. Today's comments may include forward-looking statements, which involve risks and uncertainties described in our news release and SEC filings. Actual results may differ materially. We will also reference certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are available in today's news release and financial supplement on our website.

Now I'd like to turn the call over to George. George?

Thank you, Sean and good morning, everyone. I will start with an overview of the results we reported this morning and then Mike will provide more detail. While our results continue to reflect the challenging environment for quality-oriented equity strategies, there were several positive underlying trends during the quarter, which included a meaningful improvement in total net flows, over $1 billion of positive net flows, excluding the quality equity strategies, our strongest quarter of institutional sales and net flows in nearly 3 years, positive net flows in alternatives, fixed income and multi-asset strategies, higher sales across multiple products, including institutional, wealth management and ETFs and continued return of capital to shareholders while reducing debt. We also continue to broaden our product offerings in areas where we see attractive growth opportunities.

During the quarter, we introduced new actively managed ETFs from Duff & Phelps and Silvant, further expanding our ETF platform and providing clients with differentiated investment solutions. ETFs have continued to generate positive net flows. And for perspective, our ETF business has grown significantly from just $1 billion 5 years ago and generated $2 billion of net flows in the past year alone. We remain focused on expanding our capabilities and product offerings in ETFs and other areas where we see growing client demand and attractive opportunities for long-term growth.

Turning to investment performance. Outside of quality equity, our performance remains strong across periods. Fixed income and alternative strategies have had consistently strong performance with 80% and 67%, respectively, beating benchmarks for the 3-year period. Over the longer 10-year period, 73% of our fixed income and 67% of alternative strategies beat their benchmarks. Our equity investment performance reflects our overweight to quality-oriented equity strategies. These strategies have had the opportunity to demonstrate strong performance in more constructive markets, which have been absent for the past 2 years. However, we have seen indications of the impact of such opportunities, for example, in the most recent period since late June.

While it is still early in the quarter and a very short time frame, nearly every quality strategy has been outperforming its benchmarks quarter-to-date and some meaningfully so. The improvement has coincided with a broadening market environment that is more supportive of fundamentally driven active security selection and is consistent with the type of market in which these strategies have historically performed well. Again, with such a short period, it's difficult to draw a conclusion on the cycle but it does demonstrate the opportunity when it does change.

Looking at our second quarter results. Assets under management were $152 billion at June 30, up from $149 billion, primarily due to market performance. Total sales increased 5% to $6.1 billion with higher sales of institutional, wealth management and ETFs. For institutional and wealth management, it was our highest level of sales in several years. Total net outflows improved to $5.6 billion from $8.4 billion due to both higher sales and lower redemptions. By product, net flows improved sequentially for institutional, intermediary-sold retail separate accounts, ETFs and wealth management. Looking at flows across asset classes and consistent with prior quarters, the net outflows reflected the continued style headwind from quality-oriented strategies. Outside of those strategies, positive net flows were broad-based across managers spanning fixed income, alternatives, multi-asset and equity strategies that do not have quality orientation.

In terms of what we've seen in July, U.S. retail fund sales and net flows are tracking more favorably than in each month of the second quarter and ETF net flows continue at a similar pace. On the institutional side, while known redemptions do exceed known wins, the sales pipeline is stronger than it has been in a year and is diversified across 5 managers and 6 strategies. In addition, we anticipate issuing a new CLO later this year. Turning now to our financial results. Earnings per share and the operating margin each increased sequentially due to the impact of prior quarter seasonal expenses, offset partially by a discrete noncash expense item related to previously issued investment professional stock awards. The operating margin was 26.1%, up from 24% and excluding the discrete item, was 28.2%.

Earnings per share as adjusted of $5.54 increased from $5.38 and were $5.97, excluding the discrete item. In terms of our balance sheet and capital, we ended the quarter with cash and equivalents of $176 million, CLO and other investments of $273 million and $220 million of undrawn capacity on our revolving credit facility. During the quarter, we repurchased approximately 70,000 shares for $10 million and paid our quarterly dividend. We continue to have financial flexibility to balance our capital priorities of investing in the business, returning capital to shareholders and maintaining appropriate leverage.

With that, I'll turn the call over to Mike to provide more detail on the results. Mike?

Thank you, George. Good to be with you all this morning. Starting with our results on Slide 7, assets under management. Our total assets under management at June 30 were $152.2 billion, up 2%, primarily due to market performance. And average assets were $153.3 billion, down 3% sequentially. Our AUM is well diversified across products and asset classes. By product, institutional accounts were 33% of AUM, U.S. retail funds represented 27% and retail separate accounts, including wealth management represented 24%. The remaining 16% consisted of closed-end and tender offer funds, ETFs and global funds.

Within open-end funds, ETF AUM increased to $5.8 billion, up $0.4 billion sequentially, reflecting continued positive net flows and up 58% year-over-year. By asset class, fixed income represented nearly 27% of AUM with offerings diversified across duration, credit quality and geography. Alternatives and multi-asset together represented over 28% of AUM, up from 21% a year ago and included positive net flows in alternatives and the addition of Keystone in the first quarter. We also have broad representation across domestic and international equities, including mid, small and large-cap strategies.

Turning to Slide 8, asset flows. Total sales increased 5% to $6.1 billion, up from $5.8 billion in the first quarter with higher sales in institutional, wealth management and ETFs. Reviewing by product, institutional sales increased to $2.2 billion from $1.2 billion with higher sales in alternatives, equities and fixed income and included a large global listed real estate inflow. This was the highest level of institutional sales in 3 years. Retail separate account sales of $1.2 billion declined from $1.4 billion in the first quarter as higher wealth management sales were more than offset by lower intermediaries sold. Wealth management sales were at their highest level since the fourth quarter of 2023. Open-end fund sales declined 14% to $2.6 billion as higher ETF sales were more than offset by lower U.S. retail and global funds.

Total net outflows improved to $5.6 billion from $8.4 billion last quarter. By product, institutional net outflows of $0.7 billion improved meaningfully from $3.2 billion last quarter, driven by both higher sales and lower redemptions and represented our best quarter of institutional flows in nearly 3 years. The majority of the redemptions continue to be concentrated in quality-oriented equity strategies. Retail separate account net outflows of $3.1 billion improved from $3.9 billion last quarter with the outflows driven by intermediary sold quality-oriented equities. Wealth management net flows were positive. Open-end net outflows of $1.8 billion compared with $1.3 billion last quarter and included positive net flows in fixed income. Within open-end funds, ETFs continued to grow, generating $0.3 billion of positive net flows and sustaining a strong double-digit organic growth rate. For closed-end funds and tender offer funds, we reported essentially breakeven net flows.

Turning to Slide 9. Investment management fees as adjusted were $164.8 million, up 1% as a higher average fee rate was partially offset by lower average assets. The average fee rate of 43.1 basis points, up from 41.9 basis points last quarter and included approximately 1.2 basis points of incentive fees. For modeling purposes, the second quarter fee rate is reasonable. And as always, the fee rate will vary with market levels and asset mix. Slide 10 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $102.1 million declined 4% sequentially, reflecting the impact of prior quarter seasonal items, partially offset by a full quarter of expenses of a new manager and a $3.8 million discrete expense item. This nonrecurring item consisted of a noncash expense related to multiple annual investment professional stock-based awards that were fully expensed primarily due to required acceleration upon achievement of employee retirement eligibility in the quarter.

These multiyear performance-based awards will fluctuate over the measurement periods and are currently marked at the maximum level of the awards performance range. As a percentage of revenue, employment expenses were 55.6% or 53.5%, excluding the discrete item, essentially in line with our outlook. For modeling purposes, 54% is a reasonable level for the third quarter. As always, results will vary with flows and market performance.

Turning to Slide 11. Other operating expenses as adjusted were $31.9 million and included the annual equity grant to the Board of Directors of $0.7 million. Excluding the grant, the modest increase in other operating expenses reflected the full quarter impact of a new manager. I would note that even with that addition, other operating expenses declined modestly compared with the prior year period. For modeling purposes, a quarterly range of $30 million to $32 million is reasonable going forward. Slide 12 illustrates the trend in earnings. Operating income as adjusted of $47.9 million increased from $43.8 million due to prior quarter seasonality and higher investment management fees, partially offset by the discrete item. The operating margin as adjusted was 26.1% or 28.2%, excluding the discrete item.

With respect to nonoperating items, interest expense increased by $0.4 million due to higher average gross debt. With the repayment of a portion of the credit facility during the quarter, we would anticipate a modest decline in interest expense in the third quarter. Turning to income taxes. Our effective tax rate for the second quarter was 13.3%, essentially unchanged from the prior quarter level. As a reminder, our effective tax rate includes the economic benefit of our intangible tax assets. Looking ahead, an effective tax rate in a range of 13% to 14% would be reasonable to expect. Net income as adjusted of $5.54 per diluted share included the $0.43 discrete expense item. The increase from $5.38 in the prior quarter reflected first quarter seasonality and higher revenues.

Slide 13 shows the trend of our capital, liquidity and select balance sheet items. Cash and equivalents at June 30 were $176 million, up from the prior quarter due to cash earnings in excess of return of capital and repayment of debt. In addition, we had $273 million of other investments, including seed capital to support future growth opportunities. Return of capital to shareholders in the second quarter included the repurchase of 70,097 shares of common stock for $10 million. We also repaid $20 million of the outstanding amount on our revolving credit facility and anticipate repaying the remaining $30 million in the short term. Gross debt at the end of the quarter was $427 million, down from $448 million at March 31. Net debt was $251 million or 0.9x EBITDA.

And with that, let me turn the call back over to George. George?

Thank you, Mike. We will now take your questions. Jacinda, would you open up the lines, please?

[Operator Instructions] Our first question comes from Bill Katz at TD Cowen.

It's Bradley Hays on for Bill Katz. George, maybe one for you to start. While quality equities broadly lagged, you've gotten strong performance in fixed income and alts continue to trend favorably. What's driving some of the strength in those 2 buckets? And maybe some color on upturn potential within equities?

Sure. So as you know, the overweight we have to quality equities really overshadowed quite a bit because as you referenced, we've had positive flows in fixed income, alternatives, multi-asset, et cetera. So in our fixed income, we have several capabilities, right, from the multi-sector to emerging market debt, leveraged loans and investment grade. And generally, all of them have performed well and we've seen assets increase in several of the various product structures. On the alternatives side and again, for alternatives, we do include listed securities like REITs and global REIT. And as we called out in the quarter, we had a -- we're very pleased to have a large inflow into a global listed REIT capability. And then in our other equity strategies that are not quality oriented, we have seen growth in those for several quarters. Just given their relative size, it has not yet been as noticeable. We're optimistic that, that can change going forward.

So I think all of those areas on their own are actually in a very competitive opportunity and we would ultimately expect them hopefully to continue to grow. But again, the overshadowing of the quality is obviously there. We were pleased to see a reduction in the level of outflows just given that the outflows have come down a bit but sales have also gone up. And as we're very clear in saying, while it's only really a short period of time, it was very nice to see a full month so far of significant outperformance in some of the select quality-oriented strategies. Again, that is the statement that those types of strategies want to make that when they're in favor, they can have significant performance and some of those strategies as we indicated, were meaningfully strong. Again, short period of time, too early to know whether the tide is turning. But again, from our perspective, it shows why investors should be diversified into different types of strategies so that you can balance out the cycles of different equity strategies.

Makes sense. So then maybe a bit more of a narrow question. On the lumpy comp expense, anything to be aware of in the coming quarters or in '27? And related to that, how much of the 3Q comp guide is driven by future discrete items?

Yes. I think the going-forward guide at 54% just takes into account the current state of the business. I think the discrete item was just that. It was stock-based and an acceleration of multiyears of performance-based investments, professional awards. So the good news is there was strong investment performance, as George alluded to, across strategies that given the retirement eligibility was all recognized in 1 quarter. But going forward, I would expect 54% to be the right level for modeling.

Depending on revenue because revenue actually, in some ways, impacts that margin almost more in some quarters than the employment expense.

Makes sense. And then you mentioned expecting to issue a CLO later this year. Any color on size, timing or perhaps capital to be invested on your end?

Historically, the last few that we've done, we've sized in the $300 million to $400 million range. And generally, I think they've been in the mid-20s to low $30 million range in terms of capital. Again, too early to give the specifics on that but that's generally the range that we have previously targeted and is reasonable for going forward.

Our next question comes from Ben Graham at Piper Sandler.

I'm looking just for an update on Keystone, particularly First Brands exposures. Keystone funds have exposures to a good size of loans that Keystone has self-identified as being in default or tied to a bankruptcy based on its portfolio of investment supports but they're marked at par, around par. So just wondering if you could give an update there. Just why does it make sense for those to be marked that way and carry that par, near par.

Yes. Again, we previously commented on that. The Keystone fund had exposure to First Brands and there is exposure out there. And again, the way that it is structured has not had implications and is not at the level that you may be thinking about. So currently, there is no update in terms of any kind of impact but the expectation is that there should not be any further impacts. I missed your -- I don't understand your specific question. I'm not sure what you were asking. Are you talking about something in the filing?

Sorry?

Can you repeat? I could not get the specific nature of your question.

Okay. Of course. Yes. So just wondering if for the loans that Keystone has self-identified as being in default or tied to a bankruptcy, they're marked at par around par. So I'm just wondering kind of what the rationale there is, or if it makes sense to be marked that way or carries at par, near par.

When you say -- I'm sorry, I don't know which loan -- again, they do financing and there are exposures and they use standard methodologies for mark-to-mark. So yes, I'm sorry, I'm not clear on specifically what you're referring to marked at what.

No, that -- to be honest, that kind of gave me the color I was looking for there. So I appreciate it. I can move on. I just had another question as well just on flows, more specifically on how they remain concentrated in your quality-oriented equity strategies. I'm just wondering also if you see this primarily as a style or performance cycle issue that would reverse with perhaps a rotation back to quality or if it's more of a structural or distribution-related redemptions embedded that persist regardless of performance there?

Yes. No, I mean our view is that this really is a cyclical matter where our quality-oriented strategies, when they have been in favor and have generated strong performance have been our biggest asset gatherers. And in this very -- from our perspective, painful period over the last 2 years, where the factors that are included in quality have significantly underperformed momentum that have driven those outflows. We do not think that the strategies themselves are doing anything other than sticking to their knitting. But again, their stock selection will be based upon factors that the market has not been rewarding as much as more momentum names. Again, so we're hopeful that as the cycle changes and again, we've seen a very short period of time but it does show the impact of going from things that are in the bottom percent all the way up to the top percent in a very short period of time depending upon the cycle changes. So we do look at that as more of a market cycle in and out of favor as opposed to anything else.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Aylward.

I want to thank everyone for joining us today and certainly encourage you to reach out if you have any other further questions. Thank you.

That concludes today's call. Thank you for participating. You may now disconnect.

Good morning. My name is Didi, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website at www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. [Operator Instructions]

I will now turn the conference to your host, Sean Rourke.

Thanks, Didi, and good morning, everyone. Welcome to Virtus Investment Partners discussion of our first quarter 2026 financial and operating results. Joining me today are George Aylward, our President and CEO; and Mike Angerthal, our Chief Financial Officer. After their prepared remarks, we will open the call for questions.

Before we begin, I'll refer you to the disclosures on Slide 2. Today's comments may include forward-looking statements, which involve risks and uncertainties described in our news release and SEC filings. Actual results may differ materially. We will also reference certain non-GAAP financial measures. Reconciliations of the most strictly comparable GAAP measures are available in today's news release and financial supplement on our website.

Now I'd like to turn the call over to George. George?

Thank you, Sean, and good morning, everyone. I'll start today with an overview of the results we reported this morning, and then Mike will provide more detail.

Although the first quarter was challenging from a net flow perspective, reflecting our meaningful exposure to quality-oriented equity strategies, which have remained out of favor, we had several areas of strength during the quarter that were overshadowed, and we also advanced key growth initiatives. Key highlights of the quarter included an 8% increase in sales with growth in U.S. retail funds, separate accounts and global funds, positive net flows in several strategies, including high conviction growth equity, multi-sector fixed income, listed real assets and event driven, positive net flows in ETFs and global funds, expansion into private markets with our investment in Keystone National Group and continued return of capital, including $10 million of share repurchases.

We remained active in broadening our product offerings to meet the evolving client demand and expand our growth opportunities over time. The investment in Keystone on March 1 added a differentiated asset-centric private credit capability and our sales teams are actively focused on expanding distribution of their compelling strategies to retail institutional clients. Keystone focuses on senior secured amortizing fixed rate financings backed by tangible assets. We believe their approach offers attractive stability and defensive characteristics for investors seeking a private credit allocation or a broader income-oriented solution with a different risk profile than many traditional direct lending vehicles. Keystone expands our private market capabilities, which also include those of Crescent Cove, as well as our overall alternative offerings that include managed features and event-driven strategies.

We continue to launch attractive actively managed ETFs including emerging markets dividend, ETF from our systematic team, our real estate income ETF from [indiscernible] and a growth equity ETF from Silvant. We expect to continue to be active in developing and introducing new products over the upcoming quarters.

Looking at our first quarter results. Assets under management were $149 billion at March 31, down from $159 billion due to net outflows and market performance. Total sales increased 8% to $5.8 billion, with a 26% increase in sales of equity strategies in large part from some of our strategies that do not have a quality orientation. By product, we had higher sales of U.S. retail funds, retail separate accounts and global funds. Retail separate account sales increased 19%, with higher sales in each month of the quarter. And on April 1, we reopened this mid-cap core strategy that had to soft closed in 2024.

Total net outflows were $8.4 billion, and of course products, the outflows were almost entirely driven by equities. I would note that the majority, over 80% of the net outflows were in the first 2 months of the quarter as net outflows improved significantly in March. Looking at flows across asset classes, the equity net outflows largely reflected the continued style headwind for quality-oriented strategies, including a meaningful institutional global equity redemption and the previously disclosed rebalancing of a lower fee retail separate account model only mandate to a passive strategy. Fixed income net flows were essentially breakeven for the quarter as positive net flows in multi-sector convertibles and preferreds were offset by net outflows in investment-grade and leveraged finance. Multi-Asset strategies were also essentially breakeven, while alternative strategies had net outflows of $0.4 billion, primarily driven by managed features.

In terms of what we saw in April, as previously mentioned, overall trends improved over the course of the first quarter, and April flows were more similar to March. For U.S. retail funds, both sales and flows improved in April over March, and ETF sales and net flows were at the highest levels since September. For retail separate accounts, while we do not have as much transparency given a large portion is model only, we do anticipate better flows in the second quarter and are pleased to have recently reopened the mint cap core strategy. On the institutional side, known wins actually modestly see no redemptions for the first time in a long time, though always institutional flows can be very lumpy and hard to predict.

Turning now to our financial results. The operating margin was 24% and reflected the impact of seasonally higher employment expenses. Excluding those items, the operating margin was 30.3%. Earnings per share as adjusted of $5.38 decline from the fourth quarter, primarily due to $1.26 per share of seasonal employment expenses. Excluding those items, earnings per share as adjusted declined 6%.

Turning to investment performance. As we've previously discussed, recent performance reflects our overweight in quality equity. However, we did see improving relative performance in the first quarter in our equity strategies. Fixed income and alternative strategies have consistently strong performance with 78% and 71%, respectively, beating benchmarks for the 3-year period. Over the longer 10-year period, 54% of our equity, 73% of our fixed income and 71% of alternative strategies beat their benchmarks. In terms of our balance sheet and capital, we ended the quarter with cash and equivalents of $137 million, other investments of $269 million and $200 million of undrawn capacity on our revolving credit facility.

Cash was lower sequentially as the first quarter of each year is our highest period of cash utilization. In addition to first quarter seasonal expenses, cash usage included the $200 million closing payment for the Keystone investment and $23 million, representing the majority of our remaining revenue participation obligation. During the quarter, we repurchased approximately 73,000 shares for $10 million and paid our quarterly dividend. We continue to have financial flexibility to balance our capital priorities of investing in the business, returning capital to shareholders and maintaining appropriate leverage.

And with that, I'll turn the call over to Mike to provide more detail on the financial results. Mike?

Thank you, George. Good to be with you all this morning. Starting with our results on Slide 7, assets under management. Our total assets under management at March 31 were $149 billion and average assets declined 4% to $158.2 billion.

Our AUM continues to be well diversified across products and asset classes. By product, institutional accounts were 33% of AUM, U.S. retail funds represented 27% and retail separate accounts, including wealth management, represented 25%. The remaining 15% consisted of closed-end funds, global funds and ETFs. Within open-end funds, ETF AUM increased to $5.4 billion, up $0.2 billion sequentially on continued strong net flows and up 58% year-over-year. We are also well diversified by asset class with broad representation across domestic and international equities, including mid, small and large cap strategies and fixed income offerings diversified across duration, credit quality and geography. With the addition of Keystone during the quarter, which added $2.3 billion of AUM, alternatives now represent over 12% of assets, up from 9.7% last quarter and 9% a year ago.

Turning to Slide 8, asset flows. Total sales increased 8% to $5.8 billion, up from $5.3 million in the fourth quarter. The increase was led by sales of equity strategies, which increased 26% with the growth broadly across domestic, international and global equity. Reviewing by product. Institutional sales were $1.2 billion versus $1.4 billion last quarter with higher equity and multi-asset sales offset by lower fixed income and alternatives. Retail separate account sales increased to $1.4 billion from $1.2 billion in the fourth quarter, primarily due to a 30% increase in sales in the intermediary sold channel across strategies. Open-end fund sales increased 11% to $3.1 billion and included $0.6 billion of ETF sales. Open-end fund sales were higher in equities, fixed income and multi-asset strategies, with much of the increase in equity sales in style agnostic and growth strategies.

Total net outflows were $8.4 billion compared with $8.1 billion last quarter. And as previously mentioned, the outflows improved meaningfully in the last month of the quarter. Reviewing by product, institutional net outflows of $3.2 billion were again primarily due to redemptions of quality-oriented global equity strategies. Retail separate accounts had net outflows of $3.9 billion, which included a $1.4 billion redemption of a lower fee model only account that we previously disclosed. Open-end fund net outflows of $1.3 billion improved from $2.5 billion last quarter and included positive net flows in fixed income and global equity. For closed-end funds, which include Keystone's tender offer fund, we reported modestly negative net flows. I would point out that while Keystone's fund had positive net flows for the quarter, power results reflect just 1 month of their sales, but a full quarter of redemptions, given the fund's quarterly tenders take place in March. ETFs continued to deliver solid growth, generating $0.3 billion of positive net flows and sustaining a strong double-digit organic growth rate.

Turning to Slide 9. Investment management fees, as adjusted, were $163.5 million, down 3% due to lower average AUM, partially offset by a higher average fee rate. The average fee rate was 41.9 basis points, up from 40.6 basis points last quarter and included approximately 0.6 basis points of incentive fees from 1 month of Keystone. For modeling purposes, an average fee rate in the range of 43 to 45 basis points is reasonable for the second quarter, reflecting a full quarter of Keystone. As always, the fee rate will vary with market levels and asset mix.

Slide 10 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $106.2 million increased 11% sequentially, reflecting $11.4 million of seasonal employment expenses related to the timing of annual incentives, primarily incremental payroll taxes and benefits. On the more comparable year-over-year basis, employment expenses declined 3%. Excluding the seasonal items, employment expenses also decreased on a sequential basis. Employment expenses were 58.3% of revenues as adjusted, with the sequential increase primarily due to the seasonal expenses. Excluding those items, employment expenses were 52% of revenues, higher than the fourth quarter, largely due to lower revenues.

For modeling purposes, it's reasonable to assume employment expenses as adjusted will be in the 51% to 53% range as a percentage of revenues and at the high end of that range in the second quarter, primarily due to the decline in equity assets under management. And as always, results will vary with flows and market performance.

Turning to Slide 11. Other operating expenses as adjusted were $30.6 million, up modestly from $30.2 million in part to the addition of Keystone during the quarter. For modeling purposes, a quarterly range of $31 million to $33 million is reasonable going forward to reflect the full quarter impact of Keystone. In addition, keep in mind that our annual Board of Directors' equity grant occurs in the second quarter and is incremental to the outlook.

Slide 12 illustrates the trend in earnings. Operating income as adjusted of $43.8 million decreased from $61.1 million in large part due to seasonal expenses. Excluding those items, operating income decreased 10% primarily due to lower average assets under management. The operating margin as adjusted of 24% compared with 32.4% in the fourth quarter. Excluding the seasonal employment expenses, the operating margin was 30.3%. With respect to nonoperating items, interest and dividend income declined by $1.4 million due to a lower cash balance reflecting the timing of the Keystone investment and seasonal cash obligations. Noncontrolling interest of $1.4 million were modestly lower than the prior quarter. Looking ahead for modeling purposes, we believe that a reasonable range for noncontrolling interest will be $4 million to $5 million, which factors in a full quarter of Keystone.

Turning to income taxes. As we recently announced, beginning with this quarter's results, we updated how we reflect income taxes in our non-GAAP presentation and have recast the relevant line items in prior quarters. Over time, through acquisitions, we have built a significant intangible tax asset that generates meaningful economic tax benefits. Given the size of this attribute, and our expectation of realizing benefit, we believe it is appropriate to reflect it in earnings. For context, the tax benefit represented about $2.64 per share of earnings in 2025. For the first quarter, our effective tax rate of 14% was lower sequentially by approximately 400 basis points due to the impact of the amortization tax benefit on a seasonally lower level of pretax income.

Beginning with the second quarter, an effective tax rate of 14% to 15% would be reasonable to expect. Net income as adjusted of $5.38 per diluted share, which included $1.26 per share of seasonal expenses compared with $7.16 in the fourth quarter and declined 16% from the prior year primarily due to lower average AUM. Slide 13 shows the trend of our capital, liquidity and select balance sheet items. On March 1, we completed the 56% investment in Keystone for $200 million. As a reminder, there is up to $170 million of additional consideration over 2 years, a meaningful portion of which is subject to achievement of revenue targets. The estimated fair value of the deferred payments is recorded on the balance sheet as contingent consideration. Contingent consideration at March 31 totaled $126 million, with the sequential increase reflecting the addition of the Keystone deferred payments, partially offset by the payment of the majority of our remaining revenue participation obligation, which was $23 million.

As previously discussed, our transaction with Keystone includes increasing our ownership to 75% with the equity purchases taking place during years 3 through 6 after closing. The estimated value of those purchases is recorded in redeemable noncontrolling interest, which increased to $131 million at March 31. The remaining 25% of Keystone is reflected in the manager noncontrolling interest liability, which totaled $152 million, the majority of which represents Keystone equity held by Keystone employees that will be recycled to future generations. Cash and equivalents at March 31 were $137 million, down from December 31 due to the payment for Keystone, seasonal employment expenses and return of capital. In addition, we had $269 million of other investments, including seed capital to support future growth opportunities.

Return of capital to shareholders in the first quarter included our quarterly dividend and the repurchase of 73,463 shares of common stock for $10 million. Gross debt at the end of the quarter was $448 million, up from $399 million at December 31 due to a $50 million draw on our revolving credit facility. Net debt was $311 million or 1.1x EBITDA. As a reminder, we typically prioritize repayments of amounts drawn on our credit facility over the short term.

And with that, let me turn the call back over to George. George?

Thank you, Mike. We will now take your questions. Didi, would you open up the lines, please?

[Operator Instructions] And our first question comes from Crispin Love of Piper Sandler.

First, in the release and also on the call, you called out the 26% increase in sales of equity strategies. Can you just -- can you dig into that a little further? Was that partially buying the dip in the quarter, especially the March improvement in flows and then just any specific areas, value growth, value or growth. Just curious if you can detail that a little bit more and if that's continued in April.

Sure. So again, while we've highlighted the fact that the majority of our equity AUM and strategies do have a quality orientation from the managers that have grown the business over the years that we had other strategies that did not have those same orientations. And they were -- many of them were obviously a little smaller and had not previously been areas where we have seen significant growth. That -- those have been the strategies that we have continued to focus on and try to find additional opportunities for them.

So we were very pleased with some of our strategies, which include some of the high conviction strategies, some of the more style agnostic strategies or the other growth strategies that we've recently made available in SMA have increased our focus on some of the other wrappers they're in and including launching some ETFs recently, you may have noticed that are not with our quality oriented strategies. Those have been the big drivers of that increase in assets. We hope that, that will continue. Again, we still fully believe that the quality orientation strategies will come back into favor as well. But again, we have been focused on those other strategies and capabilities that we've had, which have been smaller, but now they have been growing and our hope would be to continue to make them available, particularly again in the retail separate accounts. And very recently, now there'll be more available in the ETFs.

Mike, anything you would add other...

Yes, I think you hit on the key points. I think we're starting to see contribution on the top line from some of those managers, and they have experienced growth. Obviously, it's been overshadowed by some of the larger managers who have a quality orientation, but we're seeing that growth. I think we called it out in the intermediary-sponsored retail separate account platform. As George mentioned, we've seen expanded access at some of our key distribution partners, and that's benefiting the top line. So we're pleased to see that.

Great. Second question is on net outflows, and you might have hit on a little bit of the answer and just said, but net outflows remain elevated, especially so after the last -- over the last few quarters. So curious on the longer-term trajectory that needs to be done? What needs to be done for that to improve first at a macro level and then on a micro level on the micro side, it looks like you're making some progress there on some of those strategies outside of the quality orientation. But I'm just trying to get to, okay, how do you get closer or more progress closer to more neutral? And I also -- I appreciate the comments on the improvement in March and April, but just thinking more on a longer-term broad basis on flows.

Sure. Yes. And I'll start with just reiterating and getting the large percentage of the outflows, and again, we highlighted the 2 specific large mandates that drove that were in the earlier part of the first quarter and that March and then we've also indicated that April had a significantly lower level than that level in January or February or the fourth quarter. So we view that as positive.

Again, I think there's a couple of factors, you already indicated each of them. So for the quality-oriented strategies, again, as the cycle eventually will turn, we see that as a good opportunity. We do actually believe that there are currently certain investors, particularly more of the institutional investors that are fully cognizant of how out of favor growth equity, quality-oriented equity is and are looking -- hopefully, looking at this as the opportunity because inevitably, the turn of the cycle is usually when many managers, including ours, have generated some of their better performance. So we see that as an opportunity. But simple from that over the last year, we have spent a considerable amount of time creating wrappers and enhancing our sales efforts on those other strategies from the first question, which is really for those individuals that are not interested in quality orientation, in particular, having more of our style agnostic or other growth strategies or other differentiated strategies.

And again, we started to see some of that traction. It's nice to see those levels of growth. Those managers have compelling investment performance, and we increasingly are making them more and more available Separate from that, we recently completed the Keystone transaction. And as I indicated in our talking points, our wholesaler force is very excited about offering that very differentiated strategy. I think there's a great opportunity for that to be utilized in different portfolios. So we definitely see that as another area of continued opportunity for us to raise additional assets. And again, that would then hopefully complement what will eventually be the return of the higher level of demand for the quality oriented strategies.

We do also highlight the close strategy that we had because one of the reductions in our flows over the last few quarters since 2024 was just the absence of having sales in that closed strategy. So I think we commented that we're pleased to have that strategy because, again, our quality-oriented strategies and one of -- some of those managers are still some of our best-selling strategies. It's just the outflows are greater than the inflows at this point. So we want to bring in the increase the inflows and opening that strategy up will be helpful.

[Operator Instructions] This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Aylward.

Okay. Well, thank you very much, and I want to thank everyone today for joining us. Obviously, certainly encourage you to reach out if you have any other further questions, and have a great day. Thank you very much.

That concludes today's call. Thank you for participating, and you may now disconnect.

Good morning. My name is Didi, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners Quarterly Conference Call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. [Operator Instructions]

I will now turn the conference to your host, Sean Rourke.

Thanks, Didi, and good morning, everyone. Welcome to Virtus Investment Partners discussion of our fourth quarter 2025 financial and operating results. Joining me today are George Aylward, our President and CEO; and Mike Angerthal, our Chief Financial Officer. After their prepared remarks, we will open the call for questions.

Before we begin, I'll refer you to the disclosures on Slide 2. Today's comments may include forward-looking statements, which involve risks and uncertainties described in our news release and SEC filings. Actual results may differ materially. We will also refer -- we also reference certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are available in today's news release and financial supplement on our website.

Now I'd like to turn the call over to George. George?

Thank you, Sean, and good morning, everyone. I'll start with an overview of the results we reported this morning, and then Mike will provide more detail.

The fourth quarter reflected a challenging environment for us, given that quality-oriented equity strategies, which represent half of our AUM, remained out of favor, resulting in an increased level of net outflows. As we have previously noted, our quality-oriented equity strategies have delivered strong long-term performance across cycles and have previously been our largest drivers of growth when in favor. However, the market backdrop continued to favor more momentum-driven stocks, resulting in near-term underperformance.

Importantly, the impact from our quality equity strategies has overshadowed areas of strength across the business which in the quarter include positive net flows and strategies from several managers, including in growth equity, emerging markets debt, listed real assets and event driven, continued strong positive net flows in ETFs, product introductions of differentiated actively managed ETFs, expansion into private markets with two strategic investments, solid long-term investment performance with fixed income and alternatives also having strong near-term performance, continued return of capital with $10 million of share buybacks in the quarter, and a solid balance sheet, meaningful liquidity and de minimis net leverage at year-end.

We continue to execute our strategic priorities in the quarter, including broadening our product offerings, with several ETF introductions and expansion into the private markets. For ETFs, we launched three new actively managed funds in the quarter including a growth opportunities ETF from Silvant and U.S. and international dividend strategies from our Systematic team. We expect several additional active ETF launches over the next 2 quarters across managers, including [ Stone Harbor, ] Duff & Phelps and Silvant. We now have 25 ETFs spanning a range of strategies and continue to focus on broadening access to them in distribution channels.

In addition, we have several other new offerings in process or filing, including interval funds and additional retail separate account strategies. And as mentioned, we also have expanded into private markets with the previously announced pending acquisition of a majority interest in Keystone National Group, an asset-centric private credit manager and a minority investment in Crescent Cove, a venture growth Manager. I will discuss both in more detail shortly.

Looking at our fourth quarter results. Assets under management were $159 billion at 12/31, down from $169 billion due to net outflows and the impact of market performance. Total sales of $5.3 billion compared with $6.3 billion in the third quarter, which included a $4 billion CLO issuance. Total net outflows were $8.1 billion, and across products, the outflows were almost entirely driven by equities.

Looking at flows across asset classes. The equity net outflows largely reflected the continued style headwind for quality-oriented strategies. We had several meaningful institutional partial redemptions in such strategies as well as some seasonal tax loss [indiscernible] funds. Fixed income net flows were modestly negative at $0.1 billion for the quarter, and we saw positive net flows in certain fixed income strategies including multisector and emerging market debt. Alternative strategies were essentially breakeven for the quarter and positive for the trailing 12 months.

In terms of what we're seeing early in the first quarter, our U.S. retail funds continue to face headwinds, though there have been encouraging signs in the market of broadening investor sentiment and January sales were at the highest level since June and net flows at the best level since September and fixed income net flows were positive.

[indiscernible] sales and net flows continue to be strong. Within retail separate accounts, while for the month, we have seen an increase in sales, there was a large redemption from a client that rebalanced a lower fee model-only mandate to a passive strategy. On the institutional side, trends are similar to the fourth quarter with known redemptions exceeding known wins.

Turning now to our financial results. Earnings and the operating margin declined modestly, reflecting lower average AUM, partially offset by lower operating expenses. The operating margin was 32.4% and which compared with 33% last quarter. Earnings per share as adjusted of $6.50 compared with $6.69 in the third quarter.

Turning to investment performance. Recent performance reflects our overweight to quality equity, while long-term performance demonstrates we've generated solid performance over market cycles. For the 3-year period, while 39% of AUM outperformed benchmark due to challenging equity performance, fixed income and alternative strategies performed very well with 76% and 60% of AUM, respectively, outperforming benchmarks. Over the 10-year period, 62% of our equity assets, 77% of our fixed income assets and 71% of alternative assets beat their benchmarks. For just Mutual Funds, 65% of equity funds and 87% of fixed income funds outperformed their peer median for the 10-year period. I would also note that 84% of our rated retail fund assets were in 3, 4 and 5 star funds and 23 of our retail funds are rated 4 and 5 stars.

As it relates to equities, despite the style headwind, our quality-focused managers continue to invest with high conviction businesses with durable fundamentals and long-term potential. Their disciplined approach has delivered excellent returns over cycles, and we remain confident that as companies with quality characteristics come back in favor, these strategies are well positioned. With the environment year-to-date, we are pleased that although it's a short period, several of these strategies have generated very compelling performance.

In terms of our balance sheet and capital, we continue to have financial flexibility to balance our capital priorities of investing in the business, returning capital to shareholders and appropriate leverage. During the quarter, we repurchased approximately 60,000 shares for $10 million. The full year, we used $60 million to repurchase over 347,000 shares, representing 5% of beginning shares. We ended the quarter with significant liquidity, including $386 million of cash and equivalents and an undrawn $250 million revolver, positioning us for the upcoming first quarter obligations, including the closing payment for Keystone National.

Before turning the call over to Mike to review our financial results in more detail, I would like to provide some highlights on the Keystone National and Crescent Cove transactions which will allow us to provide private market offerings in differentiated strategies with strong track records.

We will acquire a 56% majority interest in Keystone, a boutique private credit manager specializing in asset-based lending to approximately $2.5 billion in assets across a tender offer fund and two private REITs. Keystone's approach differs from traditional direct lending. Its financings are secured by specific collateral, are self-amortizing with regular payments of principal and interest, have shorter durations and are structured with robust covenants and triggers. This collateral-backed covenant-rich design provides meaningful downside protection for investors who are underexposed to private markets and serves as a differentiated complement for those already invested in traditional private credit.

We see significant growth opportunities for Keystone across both retail and institutional channels. Their strategies are already available in an at-scale tender offer fund used by an established base of wealth management firms -- and we believe that meaningfully. [indiscernible] we also expect to introduce the capabilities to U.S. and non-U.S. institutional clients. We are excited to welcome Keystone's Salt Lake City-based team to Virtus and expect to close the transaction during the first quarter.

With regard to Crescent Cove, a private investment firm that focuses on providing flexible capital solutions to high-growth middle-market technology companies, we completed a 35% minority investment. Crescent Cove has built a strong track record, growing to over $1 billion in AUM across multiple private funds with a diversified client base. Their venture debt strategy offers a compelling risk-managed way for investors to gain exposure to private technology companies. We see long-term growth potential for Crescent Cove, including extensions into other products for broader client usage and we're excited to be partnering with their team.

With that, I'll turn the call over to Mike to provide some more details on the financials. Mike?

Thank you, George. Good to be with you all this morning. Starting with our results on Slide 10, assets under management. Our total assets under management at December 31 were $159.5 billion, and average assets declined 3% to $165.2 billion. Our AUM continues to be well diversified across products and asset classes.

By product, institutional accounts were 33% of AUM. Retail separate accounts, including wealth management, represented 27% and U.S. retail funds represented 26%. The remaining 14% consisted of closed-end funds, global funds and ETFs. Within open-end funds, ETF AUM increased to $5.2 billion, up $0.5 billion sequentially on continued strong net flows and up 72% year-over-year. We are also well diversified by asset class, with broad representation across domestic and international equities, including mid, small and large cap strategies and a fixed income platform diversified across duration, credit quality and geography.

Turning to Slide 11, asset flows. Total sales were $5.3 billion compared with $6.3 billion in the third quarter. Reviewing by product, Institutional sales were $1.4 billion versus $2 billion last quarter which included the issuance of a $0.4 billion CLO. Retail-separate account sales were $1.2 billion compared with $1.4 billion in the third quarter. Open-end fund sales were $2.8 billion, consistent with the prior quarter and included $0.8 billion of ETF sales.

Total net outflows were $8.1 billion compared with $3.9 billion last quarter. Reviewing by product, Institutional net outflows of $3 billion were primarily due to redemptions of quality domestic and global large-cap growth strategies. Of the total gross outflows in the quarter, 75% were partial redemptions rather than full terminations. Retail-separate accounts had net outflows of $2.5 billion, driven by quality, small and SMID-cap equity strategies. Open-end fund net outflows of $2.5 billion compared with $1.1 billion last quarter, also driven by quality-oriented equity strategies which more than offset positive ETF flows. ETFs continued to deliver strong momentum, generating $0.6 billion of positive net flows and sustaining a strong double-digit organic growth rate.

Before turning to the financial results, I would note that outlook commentary that I provide beyond the first quarter contemplates a full quarter impact of Keystone National. Turning to Slide 12. Investment management fees as adjusted were $168.9 million, down 4% due to lower average AUM and a modestly lower average fee rate. The average fee rate was 40.6 basis points, which compared with 41.1 basis points last quarter. For the first quarter, an average fee rate of 41 to 42 basis points is reasonable for modeling purposes. And looking beyond the first quarter, we anticipate the average fee rate will be in the range of 43 to 45 basis points. As always, the fee rate will be impacted by markets, and the mix of assets.

Slide 13 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $95.8 million decreased 3% due to lower variable incentive compensation. As a percentage of revenues, employment expenses as adjusted were 50.7% and within our range of 49% to 51%. As a reminder, the first quarter will include seasonal employment expenses which are incremental to this range.

Looking beyond the first quarter, we anticipate that employment expenses as a percentage of revenues will be in a range of 50% to 52% as the benefit from the addition of Keystone is more than offset by the decline in equity AUM. As always, it will be variable based on market performance, in particular, as well as profits and sales.

Turning to Slide 14. Other operating expenses, as adjusted, were $30.2 million, down from $31.1 million due to discrete M&A-related costs in the prior quarter. We have maintained other operating expenses within our $30 million to $32 million quarterly range for several years. And for modeling purposes, this remains appropriate for the first quarter. Looking beyond the first quarter, we believe a quarterly range of $31 million to $33 million is reasonable.

Slide 15 illustrates the trend in earnings. Operating income, as adjusted, of $61.1 million compared with $65 million in the third quarter, with the decline due to lower average assets, partially offset by lower operating expenses. The operating margin, as adjusted, of 32.4%, decreased 60 basis points from the third quarter.

With respect to nonoperating items, noncontrolling interests of $1.5 million decreased from $2.1 million due to the increase in ownership of our majority-owned manager. For modeling purposes, this level is appropriate for the first quarter. Beyond the first quarter, we believe that a reasonable range for noncontrolling interest will be $5 million to $6 million, which factors in the Keystone minority ownership.

Our effective tax rate of 25.3% was lower by 70 basis points sequentially due to an update to our blended state tax rate, and this rate is appropriate for modeling purposes in the first quarter. Beginning with the second quarter, we anticipate an effective tax rate of 23% to 24% due to the addition of Keystone.

Net income, as adjusted, of $6.50 per diluted share declined 3% and from $6.69 in the prior quarter.

Slide 16 shows the trend of our capital liquidity and select balance sheet items. Cash and equivalents at December 31 were $386 million. In addition, we had $306 million of other investments, including seed capital to support growth initiatives. The $1 million decline in outstanding debt reflected the quarterly required amortization [indiscernible] payment on the new term loan.

Gross debt to EBITDA was 1.3x, and we ended the quarter with $13 million of net debt. During the fourth quarter, we repurchased 60,292 new shares of common stock for $10 million. Other uses of capital during the quarter included the $40 million closing payment for Crescent Cove that is included in the $61 million of investments equity method row which also includes our minority investment in [ Zevenbergen ] as well as $9 million for an increase in equity of our majority-owned manager, which was the last of the scheduled equity purchases.

In the first quarter, cash usage will include our annual incentive payments, typically our highest operating cash outlay of the year and the annual revenue participation payment which we expect to approximate $22 million, which represents most of the remaining obligation. And as previously mentioned, we will make the $200 million payment for Keystone National upon closing the transaction. Taking into account that payment and other first quarter activity, we would anticipate net leverage at March 31 of 1.2x EBITDA.

With that, let me turn the call back over to George. George?

Thank you, Mike. We will now take your questions. Didi, will you open up the lines, please.

[Operator Instructions] Our first question comes from Ben Budish of Barclays.

Maybe first, just on the fee rate. Mike, you gave some color on the quarter and the year. Just curious if you could flesh that out a little bit more. What was the driver of the fee rate compression in the quarter? I assume Q1 guidance is kind of based on what you're seeing year-to-date and the full year is going to be benefited from Keystone. But just any more color on the underlying dynamics would be helpful.

Yes. As you know, we've operated our fee rate in a relatively narrow range for quite some time. I think if you normalize the 40.6 basis points in the first quarter, you get to about 40.9, just under 41 basis points as we had some discrete expenses, especially on the ETF side. So normalizing that, you have a kind of flat profile quarter-over-quarter. So we've been able to maintain that.

And looking off of that 40.9, we gave the range in the first quarter, 41 to 42. So you have that level. And we're anticipating 1 month of impact from Keystone as we're on target for closing on March 1, as we've talked about. So when you factor in 1 month of Keystone in addition to where we ended the fourth quarter, we think that range is appropriate for modeling and represents our ability to keep our fee rate in that narrow range over time.

Okay. Helpful. And then maybe just a strategic question. I know you just did a transaction, so I apologize that we're already asking about the next one. But George, in your prepared remarks, you talked about market-wide headwinds, especially to kind of value-oriented strategies where you over-indexed. I'm just curious -- I understand over the last few years, the line of question has probably been more around private markets, private credit. But just as you're thinking about future transactions, do you see that as an avenue for additional diversification? Does it make sense to broaden your kind of growth equity footprint? And perhaps, could you remind us today how much of the AUM is more kind of growth versus value oriented?

Sure. And so a couple of things. So I think as we think about diversification in addition to diversifying our offerings, right? So our goal is to provide the building blocks for well-diversified portfolio. So we continue to build those out. But the other area of diversification, we also think about a lot is where our clients are and what channels we're in.

So I think when we previously talked about M&A, we've obviously talked about adding compelling differentiated strategies. We've also said areas of interest to us would include those things that would either broaden our distribution footprint, particularly outside the U.S. as well as in other channels where we think there's more opportunity for us to garner penetration.

In terms of overall strategies, again, a lot of dialogues around private markets, and we do agree that private markets have an important place in a portfolio, but that's not the 100% of the portfolio. So we do continue to think about the other elements of the traditional managers. Right now as we're living through an overweight towards what I would define as quality-oriented strategies, which include both core value and growth sort of a quality nature, we do have other managers who are more growth equity. They've been our smaller managers. But I think as we said on our previous call last quarter as well, we've actually seen growth there. They're just unfortunately smaller than our largest managers that have more of that quality orientation.

So a lot of the ETFs and SMAs that we've been launching over the last quarter or 2 have been in those other kind of growth equity managers and particularly where we see areas outside of the traditional U.S. basis, so some non-U.S. strategies as well with that. So we've been focusing in on like Silvant, which is not a quality-oriented manager, it's more style agnostic. That has been an area of growth for us, and we've created several ETFs that have already launched several or in filing. So we continue to work on those strategies. And even within some of our value managers who are classic value managers, some of them have actually had very strong compelling performance in the recent quarters, and we look for opportunities to grow those.

So we'll continue to evaluate other things that we can add through M&A. But again, it wouldn't only be limited to those things, which provide another investment strategy. It could be things that have other strategic elements to help just overall drive growth on the long term.

And our next question comes from Crispin Love of Piper Sandler.

First, can you share what your software exposure is across your AUM? And then relatedly, just exposure at Crescent Cove advisers given their focus on technology and just overall thoughts just given the news that's been permeating the headlines this week.

So in terms of overall just technology and software exposure?

Yes.

Yes. I mean one of the things that has been a drag on the performance of some of our quality-oriented equities is they are just generally, as a rule, underweight areas of technology. So that's why this recent period, in particular here yesterday was actually very good for many of our managers.

So generally, I think as a complex, we are underweight exposure to technology. But again, not all technology is created equal, right? So there are some that will actually meet the definition of some of our managers and some will not. And then in terms of Crescent Cove, I mean they're in a different part of the market as it relates to the venture part and the earlier growth opportunities. So again, that is an area of focus for them. And again, I think long term, that continues to be a compelling area of investment. Mike, any other anecdotes you would add?

I would just say at Crescent, they don't have specific holdings that are at risk of being disintermediated by AI. So as George said, those are early-stage entities. But you highlighted the key point in the existing portfolio for Virtus, we're well underweight some of these software names. .

Great. That's what I thought, but I just wanted to make sure and all very helpful color there. And then can you dig into the flow picture from the fourth quarter? And then as you look forward, just fourth quarter was very challenging across open-end SMAs, institutional. Can you just discuss a little bit what drove the acceleration and negative flows quarter-to-quarter? The story line seem to be roughly similar from the third quarter commentary. And then just as you look at the fourth quarter move into the first and kind of the longer-term outlook, just how you feel about the flows.

Yes. And as you said and as we said in our remarks, it was definitely a challenging quarter, right? So our quality -- we're overweight, half of our AUMs are in quality-oriented equity strategies, they've had the longest period of underperformance versus more momentum types of strategies in decades. That has been quite a challenge.

As that culminated in the fourth quarter, again, fourth quarter, a lot of time will there be either traditional just tax loss harvesting or other repositionings of portfolios for year-end. So it was a higher level of outflows than we have seen previously. But what that means going forward, it's hard to know, right? It all depends on what does that market environment look like, right? If the market environment that we've seen in the last month and 5 days, were to continue, as I alluded to, that's actually been an incredibly strong environment for some of those same strategies. And I think, as I said on an earlier call, generally, when there's an inflection in the cycle is usually when you have some of the strongest performance from some of these strategies.

It's so way too early. No one knows what that's going to look like, which goes to an earlier question that I had is why we continue to focus not only on the opportunity for when these strategies return to favor but to continue to look for opportunities to grow our other strategies that don't have the same quality equity kind of orientation. So our hope is that the long-term value of the quality-oriented equity strategies will demonstrate itself and people will again avail themselves of those strategies. But in the meantime, we're looking to grow other areas of the business.

And our next question comes from Bill Katz of TD Cowen.

So first question is just in terms of the Keystone transaction. Now that you've had a little more time to interact with the management team post the announcement from a few weeks ago. Can you talk a little bit about maybe any kind of refined go-to-market opportunity? I think you spoke to potentially leveraging through your distribution channel and/or institutional, which makes a ton of sense. But just where do you see the greatest opportunity for that growth by channel or by geography? I'd love to hear your perspective on that.

Yes. No, great, great question. And we've had lots of conversations with management and -- prior to and post transaction. And I think one of the joint goals is the excitement that we all have about the opportunity to leverage what they currently have and they've been very successful with in the wealth management channel with our broader distribution resources. So our sales teams have spent multiple sessions being trained and prepped and they're all very excited and very eager to introduce those capabilities to not only our existing relationships that as well as other relationships that we can more easily develop now that we have access to this.

So we think there's a great opportunity set going forward. We do think the approach that they take on the private credit side, which is asset based in nature as opposed to the direct lending, is a very differentiated approach. Their main vehicle does not utilize the higher level of leverage that some of the competitors do. So we think there's a great opportunity. It's -- the fund they have is already retail ready. It's already being utilized by wealth management firms. As I said in the prepared remarks, we believe we can accelerate that meaningfully.

So that does create a -- what would logically be the earliest opportunity set, right, is to leverage what they've already built, it is already attractive in the wealth management space, but just through the more extensive resources that we currently have. But as I also mentioned, we think there's some really interesting opportunities on the institutional side where this strategy, again, as a complement to other types of private credit could be very compelling.

So overall, we entered into this transaction because we thought there was a great a combination that could create some long-term growth. The teams that are responsible for driving that growth, we're all very excited about this opportunity. So we're going to continue to refine that. And as Mike alluded to, we're on target for our closing transaction date. And we're getting everything prepared in advance of that. So our sales teams -- we're not waiting to close to get educated and do our planning. But all of the plans are in place and the material and everything. So we're very excited and look forward to closing on the transaction.

Okay. And just a follow-up with a clarification. On the follow-up, I was wondering if you could speak a little bit to maybe the capital deployment priorities and how that might be shifting given you have Keystone and Crescent sort of in the wings here versus how the stock has been behaving. I appreciate the buyback. But any sort of shift in your allocation thought process?

And then on the deal pipeline, [indiscernible] what have done for me lately, but how does that pipeline look today net of the Keystone and Crescent transactions?

Sure. In terms of priorities, again, we always take a balanced approach and in different periods, we'll either overemphasize repurchases, we'll overemphasize investments in organic growth and we always look to maintain a reasonable level of leverage. So I wouldn't say -- right now, having just completed two transactions, Mike has spoken to our upcoming obligations, which we will need to satisfy, but we will continue to place an emphasis on other areas such as repurchases which generally we have a long history of continued stock repurchase program with periodic pauses when we have other capital needs as well as a dividend. We do think the dividend is an important element of return to shareholders. I believe we've had 8 annual dividend increases. So that will continue to be something that we prioritize.

And as we've always said for M&A, that really is related to only when we have an opportunity that we truly believe is of strategic value to build long-term shareholder value and relative to our other alternatives.

In terms of that pipeline, and again, having just completed two, which is -- I assume you understand took a lot of our time, there are still opportunities that are out there. We still continue to evaluate and consider. But as always, we'll only evaluate and move forward with something if we truly believe it's additive in terms of the capability, it's additive in terms of broadening our distribution footprint or in other areas such as increases in scale, dramatically -- this is a scale business. So that is something that we also consider as much.

Okay. And just one clarification for Mike. Just in terms of the guidance, I think I picked them all up. I may just not heard or it didn't come out. For the first quarter, how should we think about the comp ratio? I appreciate the seasonal dynamic, but any sense on the ratio, just given some of the moving parts between the top line and the comp line?

Yes. As you know, the seasonal items do come forward in the first quarter. But our 49% to 51% range, is appropriate for the first quarter and then moving forward, we talked about 50% to 52% once we feather in Keystone.

That concludes our question-and-answer session. I would like to turn the conference back over to Mr. Aylward.

Okay. Well, I want to thank everyone, again, as always, for joining us, and I certainly encourage you to reach out if there's any other further questions. Thank you very much.

That concludes today's call. Thank you for participating, and you may now disconnect.

Good morning. My name is Latonya, and I will be your conference operator today. I would like to welcome everyone to Virtus Investment Partners conference call.

The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com.

The call is being recorded and will be available for replay on the Virtus website. [Operator Instructions]

I would now like to turn the conference over to your host, Sean Rourke. You may begin.

Thanks, Latonya, and good morning, everyone. On behalf of Virtus Investment Partners, I'd like to welcome you to the discussion of our announcement of our agreement with Keystone National Group. Our speaker today is George Aylward, President and CEO. Mike Angerthal, our Chief Financial Officer, will also be available for Q&A, which will follow our prepared remarks.

Before we begin, please note the disclosures on Page 2 of the slide presentation that accompanies this discussion and is available on our website. Certain matters discussed on this call may contain forward-looking statements, which are subject to risks and uncertainties, including those factors set forth in our SEC filings. These risks and uncertainties may cause actual results to differ materially from those discussed in the statements.

Today's call may also reference non-GAAP financial measures. Please see our most recent quarterly earnings material available on our website for discussions of our non-GAAP measures and reconciliations to the applicable GAAP measures.

Now I'd like to turn the call over to George. George?

Thank you, Sean. Good morning, everyone, and thank you for joining us today on short notice. I'm very excited to announce that we have signed an agreement to add Keystone National Group as a Virtus Investment Manager to expand our investment capabilities to include private market strategies.

Keystone is a distinctive private markets manager specializing in asset-based lending and a pioneer in bringing asset-centric private credit to the wealth channel through RIAs, high net worth investors and family offices. This transaction with Keystone fits well with our stated strategic objective of providing the building blocks of a well-diversified portfolio, which should include differentiated private market strategies.

Slide 3 highlights the compelling strategic rationale for the transaction. Partnering with Keystone establishes for us a foundation in private credit and real estate with a capability that is differentiated from other private credit offerings through its focus on asset-based lending, and addresses the growing demand for private market strategies, particularly uncorrelated sources of income. We see significant growth opportunities through further expansion of its established presence in the wealth channel with its flagship tender offer fund and in making their strategies available to an institutional client base both U.S. and non-U.S.

With the deep experience of Keystone's management team and their track record of compelling investment results, we also see opportunities to extend into other products for broader client usage. Keystone has an attractive financial profile having generated strong financial performance, with revenue and EBITDA CAGRs north of 35% over 3 years, with positive net flows and strong double-digit organic growth rate. I would note that we anticipate the transaction will be immediately accretive to margins and non-GAAP EPS upon closing in the first quarter of 2026.

And importantly, Keystone and Virtus operate with similar philosophies and have a strong alignment of culture and strategic priorities. Both firms share an emphasis on investment excellence, client focus and long-term value creation. Keystone managing partners will maintain significant equity and have entered into long-term employment agreements, ensuring continuity of the team, culture and strategies.

Slide 4 provides an overview of Keystone. The firm offers differentiated exposure to private credit and real estate and is known for its asset-based lending strategies anchored by disciplined underwriting and a focus on capital preservation. Since its founding in 2006 as a distinctive manager specializing in diversified asset-centric private credit strategies, Keystone has grown assets under management to $2.5 billion, primarily sourced through the RIA channel where they have meaningful long-term relationships in a large and growing private wealth base.

The firm is led by a highly experienced management team that has invested over $6 billion in more than 750 transactions spanning equipment finance, real estate finance, financial assets and asset-based corporate loans, and has delivered an attractive investment performance over nearly 2 decades.

Keystone's asset-based lending approach is differentiated from the more common private credit direct lending strategies, including a different risk profile. Keystone's asset-based lending approach differs from direct lending as its financings are generally secured by specific collateral, are self-amortizing with regular payments of both principal and interest, have a shorter duration, and includes strong covenants and triggers that may give more control and protection to the lender. This makes Keystone's strategies attractive for investors that are underexposed to private markets, as well as a good diversifier for investors with existing exposure to traditional private credit as it may provide more downside protection with its collateral-backed focus and covenant-heavy approach.

On Slide 5, we provide an overview of their current strategies. Keystone's flagship $2 billion tender offer fund, the Keystone Private Income Fund, or KPIF, which launched in 2020, has gained meaningful traction with leading wealth managers as a result of its attractive and consistent investment performance relative to other private credit interval funds and income-oriented funds more broadly. It can complement mainstream private credit funds by providing a differentiated exposure, as well as deliver an attractive yield in excess of what is generally available in traditional fixed income.

Keystone also manages 2 private REITs, investing across private real estate debt and equity, with approximately $500 million in assets under management.

I'd emphasize our excitement around welcoming Keystone's talented team of professionals to Virtus. The transaction will enhance Keystone's ability to focus on managing its distinctive strategies while benefiting from our support model. As part of the Virtus family of investment managers, Keystone will maintain autonomy over its investment process, brand and culture, have greater flexibility to focus on client outcomes and on achieving sustainable, predictable investment performance, retain significant equity ownership in the business and receive support for intergenerational transfers of equity interests, benefit from the expertise and expanded resources available as part of a larger company, and be supported by our strong distribution, marketing and client service capabilities to accelerate their growth.

Turning to a summary of the transaction on Slide 6. We would acquire a 56% majority ownership stake in Keystone for $200 million at closing, that will be funded with existing balance sheet resources. The transaction also includes up to $170 million of deferred consideration over 2 years, including earn-out payments subject to achievement of future revenue targets.

As a reminder, at the end of the third quarter, we had $371 million of cash and equivalents, an undrawn revolver with $250 million of capacity, and our net leverage was 0.1x EBITDA. After closing, we will continue to have significant financial flexibility to continue to balance investments in the business and return of capital to shareholders. And while we were not in the market to repurchase our shares in the third quarter given advanced discussions with Keystone, we do intend on resuming our buyback program.

After closing, Keystone's management team will retain an ownership position of 44%. Through put and call options in years 3 through 6, we would increase our ownership to approximately 75%. The balance of the equity will remain as a minority interest and be available for recycling to future generations.

Regarding the financial impact, we anticipate the transaction will benefit the operating margin by approximately 200 basis points and contribute about $1.50 to EPS as adjusted in 2026, assuming a March 1 closing. In addition, we expect intangible assets created by the transaction to create annual tax savings of approximately $5 million per year. We will update you on all key modeling assumptions on our next earnings call.

Before we open it up to questions, I would like to provide some additional thoughts on why we believe this is an attractive opportunity for us. Keystone is well-positioned in what we believe is a favorable environment for private market strategies in general, but particularly for differentiated, asset-centric private credit targeting attractive areas of that market.

Keystone has a track record of strong and diverse sourcing and have demonstrated themselves as a good partner in the asset-based lending market with a high level of repeat business. Their capabilities are already available in an at-scale tender offer fund that is being utilized by an established base of wealth management firms that we believe we can significantly expand.

The team at Keystone has strong and deep experience over 2 decades, demonstrated in the compelling performance they provided on a risk-adjusted basis, their low loss rates and in the returns. Their differentiated assets and credit strategies are an attractive way to gain exposure to private markets, which will complement traditional private credit. They provide a significant growth opportunity in both the retail and institutional channels.

So with that, we'll now take your questions. Latonya, would you open up the lines, please?

[Operator Instructions] Our first question will be coming from Crispin Love of Piper Sandler.

Congrats on the deal. Just first on private markets, private credit, credit quality. There have been some worries and headaches out there recently. It looks like Keystone's flagship Private Income Fund has some exposure to the First Brands issue out there. So first, can you size that? And then just your confidence in Keystone, the broader credit markets currently and how First Brands might have impacted your diligence on the company and if you think there could be any impact to flows going forward from that.

Sure. No, great question. And a lot of the commentary about "private credit and the concerns" are, generally, there is legitimacy to some of those concerns. But in many of those instances, it's really more along the lines of the more direct lending types of capabilities, right? So private credit, just like public credit, is not all one thing. And I think what we find interesting here is that this is very different approach in the private credit market to what you're seeing.

And for example, specifically on the First Brands, a lot of what you've read about in the First Brands and the exposures have really been related to the loans that are outstanding. And that is not the type of exposure that Keystone and their fund have. They actually have the asset-based equipment leasing type of strategies. And currently in their holdings, they're not expecting to have losses on those loans. You never know. But again, it is very different from the direct lending side. So they're not participating on the loan side that you're reading a lot about in that instance.

And we did spend a lot of time and we're very happy to hear how they had approached their investing in -- particularly with regard to that name, in the equipment leasing portion, as opposed to what we're seeing in some of the other holders of their actual debt. So we do think that that's one of the reasons that this is interesting, is it is different than the traditional direct lending that you're seeing where people are making loans based upon the credit of the firm. Whereas here, they're basically doing a collateralized, asset-secured, asset-heavy, covenant-heavy approach to lending money.

Okay. That makes sense. So there were no kind of issues with Keystone and First Brands with the assets that were being collateralized or anything like that?

Currently, the expectation is that based upon the underlying holdings that they have and the pools that they're contained within, they have not taken any write-downs on that.

Okay. Perfect. I appreciate that. And then you gave a lot of good financial detail on the call and also Slide 6. But are you able to share what Keystone's current fee rates are, comp ratios and then operating margins? And then just also if you could detail some of the key synergies you might expect from the deal that both you and Keystone will benefit from.

Yes. I mean I'll have Mike follow up on any of the details at this point. And again, we will be providing updates going forward. But our main focus here really is on growth. I mean what makes this interesting to us, as well as to Keystone, is we think they have a very compelling offering. That offering is already available in the wealth and RIA channels. We believe that, working together, we can be very successful in significantly expanding it. So this is really about adding to our capabilities that we offer, and growth. This is not a synergy play.

Mike, I don't know if you want to make any comments on other attributes.

Yes, Crispin. I would just reiterate the point on the overall margin expansion that we anticipate of about 200 basis points on our run rate Q3 profile. And as we get closer, I would expect on the next call we'll start to go into each line item, specifically on fee rate and employment and other operating. I think on the fee rate, we alluded to 200 basis point benefit to our blended fee rate. But we'll go into specificity around some of these details on the next call.

Our next question will be coming from Michael Cyprys of Morgan Stanley.

I was hoping maybe you could elaborate on Keystone's approach to sourcing an origination around the types of loans that they are extending, how they go about that in the marketplace. That would be helpful.

Yes. I mean I'll keep it at a high level. So again, they're really asset-centric lending as opposed to really the general direct lending. So again, in all of the types of things that they do, whether it be in equipment finance or real estate, et cetera, it's really focused on a heavy level of collateral, generally for the types of transactions that have shorter terms. So again, comparing it to the traditional private credit. These are usually 2 to 5-year kind of durations with payment streams that commence generally early, with both principal and interest payments, covenant-heavy as opposed to covenant-light, which is something you see on the traditional side.

And in terms of their sourcing, is they're focusing on a part of the market that some of the larger players would not focus in on. So their ticket sizes will generally be a little bit smaller. And they're very just focused in on those things, from a capital preservation perspective, that they can get comfortable that they can be the party lending the money through the financing or an equipment lease transaction or an inventory transaction, and less about the direct lending on the corporate side or for such things as factoring receivables, et cetera.

So they're kind of in a very interesting space that's not a crowded space and they just really specialize in what they do.

And sorry, how is it exactly that they're sourcing these loans? Do they have like dozens of lenders? Or are they partnering with banks or other types of institutions in terms of flow arrangements? Are they investing in the funds of other managers?

No, they're not investing. So they're doing their own direct sourcing and origination, and they're generally not necessarily piggybacking off some -- will piggyback off of either PE firms or other sourcing. So they have their own network of companies as well as leasing firms and leasing agents who they partner with to identify opportunities. And they have had a number of transactions, as we said. Over the years, they've done over $6 billion of investing in 750 transactions.

So they have a very large network of contacts of people that might be seeking either the equipment financing, the real estate financing, et cetera. So they're doing their own direct origination and they're not doing it generally in part and parcel with other -- with the other PE firm or another backer.

Okay. And just a follow-up question, one of the things we are hearing about in the asset-based finance space is issues in some pockets around double dipping on collateral or even some instances of fraud we've seen where collateral maybe wasn't there. So just curious, as part of the diligence that you guys have done, looking at the business, how you got comfortable with their approach to underwriting? As you look at the type of lending they do, any particular color you're able to share around how you guys got comfortable and how you went about diligencing that?

Yes. No, and we spent a lot of time on their underwriting and going through multiple case studies of the things that they've done, and they are very focused on collateral, right? So getting back to like their main approach, which is on capital preservation, a lot of that starts with the strength of collateral, senior position in collateral. Real collateral, not paper collateral, but actual -- if they're financing an actual machine, generally, they'll look for machinery that is critical to the company's future as opposed to ancillary. So they really do focus primarily first on the strength of the underlying collateral.

And again, even in a liquidation mode, so as they do the underwriting for collateral, and not just getting fair values, they're getting liquidation values so that they can be very comfortable through different risk scenarios, the collectibility of that. And I think you kind of see that in the loss ratio which they have, which is generally lower than some of the other loss ratios that you've seen in other types of private credit strategies.

Great. And if I could sneak one more in, just as you think about growing the firm and helping them accelerate their growth path, just curious like which 1 or 2 things you think could be most meaningful. Is it extending into other channels beyond the RIA, into the wires, is it international, is it institutional? Which one would you say is most -- could be most meaningful? Talk about some of the stuff you may take there to accelerate that.

And how do you think about the scalability of their strategy? I think you mentioned they operate in sort of putting out smaller tickets, smaller, different part of the marketplace. Just curious if you can speak to the scalability of that part of the channel.

Sure, sure. And on the growth, I think all of the areas that you mentioned are very exciting. But one thing that's particularly interesting here is this is -- I hate to say retail ready, but it's retail ready, right? And in certain instances, as traditionals try to partner with private markets managers, the question is, how will they develop a product that can be extended into the retail marketplace?

Their primary fund is already in the wealth space. It is widely used in the wealth space. They've been able to partner with many of the leading wealth management types of firms for that. So we already have something that, with our larger distribution footprint, we do believe that we significantly can help grow those existing capabilities.

We also see many attractive areas in the institutional space, both in the U.S. as well as outside the U.S. Keystone does not have a large sales force, and they've been very focused on what they should, which is generating good returns for their clients as opposed to a lot of marketing. So I think the fundamental, mutually beneficial aspect of the relationship is we feel very comfortable on both the retail and the institutional side. Everyone is very excited about the opportunity about bringing them to a wider number of clients.

And again, the approach that they have can be applied in other ways. So further along the line, there may be other opportunities for us to develop and extend their capabilities.

And then going to the last part of your question, they're very focused on maintaining their investment performance and the discipline they have in terms of capital preservation. So they will put money to work at a reasonable pace that they are comfortable that they can do. And because of the general part of the market that they're applying in, it's not as large as some of the larger parts of the market, but they still have a lot of opportunities to put capital to work given the extensive network of sourcing that they already have in place.

So we really do feel very, very optimistic that there's a lot of great opportunity here for us to hit the ground running quite quickly, particularly on the retail side where there is already the ability to bring to the retail marketplace an existing product that in some ways was built with the wealth client in mind.

I would now like to turn the conference back to Mr. Aylward for closing remarks.

Great. Thank you. So I want to thank everyone for joining us today. And obviously, if anyone has additional questions, please feel to reach out. Thank you so much.

And that concludes today's call. Thank you for participating. You may now disconnect.

Good morning. My name is Didi, and I will be your conference operator today. I would like to welcome everyone to the Virtus Investment Partners quarterly conference call. The slide presentation for this call is available in the Investor Relations section of the Virtus website, www.virtus.com. This call is being recorded and will be available for replay on the Virtus website. [Operator Instructions]

I will now turn the conference to your host, Sean Rourke.

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The fee rate will be impacted by markets and the mix of assets. Slide 10 shows the 5-quarter trend in employment expenses. Total employment expenses as adjusted of $98.7 million increased slightly due to higher variable incentive compensation. As a percentage of revenues, employment expenses as adjusted declined by 70 basis points to 50.2%. Looking ahead, it is reasonable to anticipate employment expenses as a percentage of revenues will remain within our recent 49% to 51% range.

Turning to Slide 11. Other operating expenses, as adjusted, were $31.1 million, down from $32 million due to lower rent expense from office consolidation and the prior quarter impact of the annual equity grants to the Board of Directors, partially offset by $1 million of discrete business initiative expenses. As a percentage of revenue, other operating expenses were 15.8%, down from 16.7%. For modeling purposes, our range of $30 million to $32 million per quarter remains appropriate.

Slide 12 illustrates the trend in earnings. Operating income as adjusted of $65 million increased 9% sequentially due to higher revenues and relatively stable operating expenses. The operating margin as adjusted of 33% increased 170 basis points from the second quarter. Excluding the discrete business initiative expenses, the operating margin was 33.4%. With respect to nonoperating items, interest and dividend income of $4.1 million declined sequentially due to elevated CLO interest income in the prior quarter.

Looking ahead to the fourth quarter, it would be reasonable to anticipate a higher level of interest income, given increased cash balances at the end of the quarter as a result of the recent debt refinancing, offset partially by lower CLO interest income. Interest expense was $4.8 million in the third quarter. It would be reasonable to assume that will increase in the fourth quarter given the higher debt level. Nontolling interest, which reflect minority interest in 1 of our managers were modestly lower primarily due to the increase in our ownership late in the quarter. A reasonable run rate for the fourth quarter is approximately $2 million.

Net income as adjusted of $6.69 per diluted share, which included $0.11 of discrete expenses increased 7% and from $6.25 in the second quarter. In terms of GAAP results, net income per share of $4.65 decreased from $6.12 per share in the second quarter due to $1.54 of unrealized losses on investments, partially offset by $0.42 of fair value adjustments to minority interests.

Slide 13 shows the trend of our capital liquidity and select balance sheet items. On September 26, we completed the refinancing of our credit agreement. Increasing the company's financial flexibility and extending the maturity profile. The new $400 million term loan has a 7-year maturity and the revolver provides $250 million of capacity through 2030, each bearing interest at SOFR plus 225 basis points. Cash and equivalents at September 30 were $371 million. In addition, we had $300 million of other investments, including Seed Capital.

During the third quarter, we raised our quarterly common dividend by 7% to $2.40 per share. Other uses of capital during the quarter included $29.7 million to sponsor the new CLO as well as $14.8 million for a planned increase in equity of our majority-owned affiliate. The last of the scheduled equity purchases of the affiliate will be approximately $7 million in the fourth quarter. At September 30, gross debt to EBITDA was 1.3x, up from 0.7x at June 30 due to the upsizing of our credit facility and we ended the quarter with $29 million of net debt or 0.1x EBITDA, which declined from 0.2x. at June 30. Our strong levels of liquidity, including the undrawn revolver, and modest net leverage provide meaningful financial flexibility to continue to invest in the business and return capital.

And with that, let me turn the call back over to George. George?

Thank you, Mike. So we'll now take your questions. Didi, would you open up the lines, please? p

[Operator Instructions] Our first question comes from Ben Budish at Barclays.

Maybe just first on the ETF side, you've noticed that -- noted that that's an area of strength. Could you just maybe unpack for us a little bit what are the key strategies that are attracting the most interest? Is it the wrapper itself? Or is it the particular strategies that are offered in that wrapper or the franchises? And how do you think about that in terms of what informs the future pipeline. You mentioned a couple of things upcoming, but as you think about the next couple of years, how are you thinking what might make sense either to launch or to kind of rewrap how you're thinking about all that?

Sure. Yes. So I think in terms of what's driving, I think it's both components. So I think the ETF wrapper itself is highly preferred by a large number of investors and financial advisers. Transparency benefits, tax efficiency. So I think in certain instances for specific strategies, it's become a vehicle of choice. In terms of what strategies people are accessing. So for us, our ETF business is a newer business, and we've been building our track records in many of our strategies.

And currently, we've seen growth occurring in several of them, particularly those that I think we noted in the alt space or that have certain kinds of return patterns that are being found to be very attractive. So I commented a little bit on some of our pipelines. We really do see a lot of opportunities for very specific types of strategies in the ETF wrapper that increasingly will be -- utilized in portfolios. I also made comments for us, getting availability for ETFs is a big focus. A lot of times with newer ETFs, it's harder to get access in certain of the subchannels. So as we grow them, and so including in this quarter, we had 1 that we got to a level of of access and that drove some of our flows this quarter. So that continues to be a priority for us.

And then just separately, I would note for the ETF share class relief, we are one of the firms that do have filings in process related to that as well.

Very helpful. Maybe just following up in terms of growth -- you mentioned inorganic opportunities in your kind of brief comments about uses of capital. Just any update on pipeline potential timing? And are there any changes in the environment that make things more or less feasible. You talked about sort of growth versus momentum. Does that sort of inform the types of assets you're interested in acquiring? Just any update there would be helpful as well.

Yes. But on the last point in terms of the quality versus momentum and again, having been in a period where, for the last 2 years, quality has significantly underperformed the momentum. That is a current event. So in terms of a long-term M&A strategy, that might not necessarily have a huge impact on it, though it would influence it. We look forward to the reversion for quality coming back into favor, which is generally when quality-oriented strategies have their best performance. So unless momentum continues to lead the markets for the next multiple years, we'll have a headwind, but when it inverts, we will be well positioned to take care of that.

In terms of inorganic, again, I repeated some of the comments from [indiscernible] core, which is that the activity remains very active and that there is a lot of opportunities in terms of things that could potentially make sense we really focus in on a very disciplined and focused approach on what really makes sense in terms of either adding another differentiated high-performing traditional capability or private market expansion or something that would allow us to have access to more clients outside U.S. Those are the 3 areas I believe we previously have commented on. And we do think all of those could potentially be interesting opportunities for us. We have nothing specific to announce at this time on anything that we're doing. But again, it continues to be a very active area for us.

And our next question comes from Crispin Love of Piper Sandler.

First, just looking big picture net flows. They've been pretty elevated for 4 consecutive quarters net outflows. When you look forward -- do you see any key levers to be able to improve those flows to get to more neutral at least less negative outside of just quality coming more into favor versus momentum?

Yes. Well, I mean, a couple of things. So we did have positive flows in fixed income strategies in the quarter. We had positive flows in alternative strategies. We have positive flows in our ETFs. And in multi-asset, I think we were kind of breakeven. So a lot of our flows are really around our overweight to quality-oriented equity strategies. Actually, our equity strategies that are not highly correlated to quality actually are in positive flows. So it's just the significant overweight that we have to those types of strategies is the reason that it's overshadowed any of the other areas that have been positive.

So what we're focusing in on primarily now while the cycle is still negative towards us, is to grow those things that don't have that same correlation. So as I commented on some of our more style-agnostic or momentum-oriented equity strategies actually were positive flows and we're actually seeing activity there, but there's just such a smaller part of our business, they're not going to overshadow the quality and the momentum.

And in terms of the quality momentum and again, this has really been -- and we highlighted how bad of a 2-year period this has been to give some examples. So the S&P MidCap quality indexes trailed the S&P MidCap momentum by about 32%, and which is really kind of ranks in the 93rd percentile of the data that goes all the way back to 1992. And actually, it's the worst level since October of 2000. And similarly, on the small cap, the Morningstar U.S. small cap quality trail the Morningstar U.S. -- are momentum by about 82%. And that's the worst level going back to 2008.

So it really has been an unusually stark underperformance of quality versus momentum for a longer period of time. And I think as I just commented previously, Historically, as they invert is usually when quality has some of its strongest outperformance, right? So in some of these strategies and some of these strategies I've personally been watching for over 20 years, they can generally have some of their best performance and then following that, some of their best flows after that inversion. So we don't fundamentally believe that lower quality less profitable, highly shorted companies are going to continue to always lead the market.

And then lastly, when we sell our strategies, we sell them how they'll fit into a portfolio, right? So generally, people aren't just buying 1 equity manager hoping for the highest return. So really where we're positioning those capabilities is really that someone should have a portion of their equity allocation not only in just the pure indexes, which is really a small number of names leading those indices, but to also then have certain allocations to either quality or other types of capabilities in the event that the markets inflect. And so I think increasingly, as people will look at, do they need to have some protection in case there is that flip, that will be an area that we would be able to take advantage of.

Great. George, appreciate all the color there. And then just second question for me on other OpEx. You had the office space consolidation. Is this something that you've been thinking about for several quarters? And then shouldn't that drive down the run rate for OpEx going forward or are there offsets in there as well? And then also, if you can just detail what the $1 million of discrete business initiative expenses were in the quarter.

Sure, Crispin. I'll jump in. It's Mike. So with respect to the office consolidation, this is the quarter that you actually see it in the run rate. Those are some actions that we have taken starting late last year and earlier this year that have now been reflected in the run rate. So we go about the $30 million to $32 million range ex the discrete items sort of coming in at the low end of that range given the benefit of that office consolidation. So we provided the transparency around the discrete items, as George alluded to, they're generally related to at elevated levels based on some of the inorganic activity that we have been focused on. So we thought providing that transparency would be helpful in the analysis of other operating.

So again, it is specific to some of those activities and at levels higher than what we would anticipate a more normalized level.

And our next question comes from Bill Katz of TD Cowen. .

Just sticking on the discrete spend here. Is that now over? Or should we anticipate that, that will persist? And then relatedly, are you back in the market for buyback present?

Yes. So on the first part of the question, again, in the prepared comments, we're clear that we're still being very active and there's still a lot of opportunities for us -- so we'll sort of stand by that and sort of saying we are still being very active in evaluating potential opportunities. And as it relates, we don't have anything specific to discuss or announce at this point. but that continues to be an area where we are being very active.

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Nothing specific to say other than we continue to view that as a core element of our capital strategy, halfway through the year, we have done $50 million, which had gotten us to the highest level of over 2 years. So that will continue to be something that we will always evaluate. But as always, we have to balance it with other factors and other considerations for that. So nothing specific on what that might be in the short term other than to say we still view return of capital as a critical part of our capital strategy.

Okay. And just as a follow-up, just going back to your commentary that the fourth quarter, the institutional trends are sort of looking like they were in prior quarter. Can you unpack that a little bit, where you're seeing strength, where you're seeing the weakness. And underneath that, I was want to wonder if you could just talk about what you're just seeing generally in terms of allocations? And I'm curious specifically about the demand for liquid alts.

Yes. And actually, 2 of the areas that actually I was actually very happy to see is, I mentioned emerging market debt, right, which is an area that I had previously maybe not been as much in favor as some of us believe it should have been. So I think I commented on opportunities that we've seen in emerging market debt as well as global REIT as well as domestic REIT. So those are really nice to see there.

I think generally, in the institutional, which for us, we have a nice non-U.S. institutional business. And I believe both of the ones I referenced are non-U.S. You kind of have a slightly different investor profile there. So that's why sometimes we can see interest in strategies that may not be as in favor in the U.S. retail market, even the U.S. institutional market, but have some opportunities there. So I mean, those are the 2 that I would highlight, but I think there's a variety of managers. Mike, I don't know if there's anything else you'd add to that.

No, I think you covered it. We've -- the pipeline is across managers and across geographies, including from our European and Middle Eastern teens.

And our next question comes from Michael Cyprys from Morgan Stanley.

Just want to ask about ETFs. I was hoping maybe you could speak to how broadly distributed your ETFs are today across the wires, IBDs, RIAs, et cetera. How that is compared to where you'd like that to be. Talk about some of the steps you're taking to expand your distribution presence for your ETFs, including in models? And if you maybe just update us on how models are contributing, if at all, today.

Yes. No, it's a great question. And specific to the comments we made and where we're focusing and one of the main areas of focus is increasing the availability of our ETFs in certain channels. Because as you're kind of intimating, getting access is not the same in every channel, right? The wires versus the RIAs as well as getting access into some of the big model providers and professional ETF buyers. So for us, we're focused on all of those areas where we are not where we want to be. We think we have a great opportunity particularly if we can get some of our ETFs up to a certain level of scale, which will matter in some of the channels, say, like the wire houses where you need a certain period of time and you need a certain asset level to have access.

We always have focused in on some of the model providers and the professional buyers. But again, I still think that's a huge opportunity for us. I mean one of the reasons that we're focused on both sides of increasing the distribution as well as increasing the offerings because we just really see that there is just a great opportunity set for us and some of the areas that we kind of focus in on as we move forward. So our hope is that the growth will come from getting a lot more of the access that we currently don't have that we do want and but then expanding those offerings to provide more building blocks for ETF models as well as for individual investors.

And I think as I commented on a previous call, another area that we focus in on is our own models and using our ETFs for solution-oriented -- outcome-oriented types of capabilities which we have seeded and designed several things along that way. So that's why it's just been a big area for focus for us. And I think as you've seen, almost all of our product development has either been on the ETF side or the global fund side as well as -- and I don't want to leave retail separate accounts out because retail separate accounts our focus there has really been on expanding the offerings we have a strong placement in retail separate accounts on the equity side, and we have been just expanding the number of fixed income offerings and have put together several structures to allow us to take advantage of that.

So that's another area that we would like to see some additional growth because we think we have a good opportunity set.

Great. And then just a follow-up question on inorganic activity. I was hoping maybe you could elaborate on the types and size of properties that you're evaluating. Talk about your process of how you're going about sifting and sorting through these properties? And remind us of your criteria and hurdle rates, does the transaction need to be accretive day 1 or within the 12 -- first 12 months? How are you thinking about that?

Yes. So -- and when we speak about the inorganic, we're covering the whole continuum of those things which are really -- could add meaningful scale those things that can add capabilities that are quite additive to our current offerings and that would also include expanding us from the public market offerings into the private markets. When we talk about inorganic, we also, because of our flexible model that could include things like joint ventures or other types of structures. So we kind of leave ourselves open to a variety of different opportunity set and kind of evaluate -- primarily, what we're trying to evaluate is the best strategic fit the financial benefit and really the long-term value creation. So we'll include a lot of factors, which will include things like accretion but will also include factors like what impact we'll have in our growth rates, et cetera.

So I don't have specific hurdles that I would provide, but we do go through a filter of various elements as we determine between 2 alternatives or 3 alternatives, what we would prioritize. The good news is, again, with our current level of net debt being de minimis and our cash flow is still generating. We do have flexibility to evaluate different types of opportunities.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Aylward.

Great. No, thank you. And I want to thank everyone today for joining us. And obviously, as always, if you have any other questions, please reach out. And thank you very much.

That concludes today's call. Thank you for participating, and you may now disconnect.