Eaton Vance (EV) Q3 2020 Earnings Call Transcript

Eaton Vance (EV)
Q3 2020 Earnings Call
Aug 26, 2020, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Vance Corp. third-fiscal-quarter earnings conference call and webcast. [Operator instructions] Please be advised that today's call is being recorded. [Operator instructions] I would now like to turn the call over to your speaker today, Eric Senay, treasurer and director of investor relations.

Please go ahead.

Eric Senay -- Treasurer and Director of Investor Relations

Thank you, and good morning, and welcome to our fiscal 2020 third-quarter earnings call and webcast. With me this morning are Tom Faust, chairman and CEO of Eaton Vance; as well as our CFO, Laurie Hylton. In today's call, we will first comment on the quarter and take your questions. As always, the full earnings release and charts we will refer to during the call are available on our website, eatonvance.com, under the heading Investor Relations.

Today's presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our business, including but not limited to those discussed in our SEC filings. These filings, including our 2019 annual report and Form 10-K, are available on our website or upon request at no charge. I will now turn the call over to Tom.

Tom Faust -- Chairman and Chief Executive Officer

Good morning, and thank you, everyone, for joining us today. Since we reported our second-quarter earnings results in late May, our business, our employees, and the communities in which we live and work have continued to be significantly impacted by the ongoing COVID-19 pandemic. Nearly all of our staff continues to work remotely, and that remains our expectation through at least the balance of this year. Our employees have adapted quite effectively to working from home with minimal disruption to day-to-day operations and high levels of client service being maintained throughout the pandemic period.

The strength and resilience of our business in this difficult environment is testament to the adaptability and commitment of our employees across the company, for which I remain deeply grateful. Since the sharp market sell-off in March, the stimulus actions of governments around the globe and visible progress advancing the development of effective COVID-19 vaccines and therapeutics have fueled a recovery in financial markets. Over the course of our third fiscal quarter ending in July, we regained $39.4 billion of the $43.6 billion of managed assets that we lost to market price declines in the previous quarter. While the pandemic is far from over, markets are increasingly willing to bet that the worst is behind us and economic recovery will continue.

Earlier today, we reported adjusted earnings per diluted share of $0.82 for the third quarter of fiscal 2020, up 3% from $0.80 of adjusted diluted earnings per -- diluted share in the second quarter of fiscal 2020 and down 7% from $0.88 of adjusted earnings per diluted share in the third quarter of fiscal 2019. On a GAAP basis, we reported a loss of $0.01 per diluted share in the third quarter of fiscal 2020, reflecting a $0.90 per diluted share reduction in the carrying value of our position in 49% owned Hexavest, together with $0.07 per diluted share of income and gains on seed capital investments and consolidated CLO entities and other items that we exclude from our adjusted earnings calculation. The reduction in the carrying value of our position in Hexavest reflects outflows-driven declines in Hexavset's managed assets and management fee revenue, which accelerated the spring and summer following disappointing investment performance in the pandemic-related March market sell-off. Throughout its history, dating back to 2004, Hexavest has employed a value-leaning preservation of capital-oriented investment style that typically generates its strongest relative returns during periods of market weakness.

Unfortunately, for Hexavest, this year's market decline did not follow the usual pattern as value stocks significantly lag gross stocks, both during the sell-off and in the market recovery to date, reflecting net outflows of $2.7 billion during our third fiscal quarter, Hexavest closed the quarter with managed assets of $6.8 billion. That compares to managed assets of $11 billion at the time we acquired our position in Hexavest in 2012, peak managed assets of $17.1 billion in 2014, and $13.4 billion of managed assets at the end of our fiscal 2019 last October. While we're disappointed that recent reductions in Hexavest managed assets and management fee revenue have necessitated writing down the carrying value of our investment, we continue to believe in Hexavest's investment approach and fully support the company's management. Hexavest business remains solid and secure and their talented investment team continues to engage actively in the markets seeking to deliver value for their clients.

Turning to our core operating results. We ended the third quarter of fiscal 2020 with $507 billion of consolidated assets under management, up 9% from the end of the previous quarter. Across our investment mandate reporting categories, increases in managed assets range from a high of 12% for fixed income and 10% for Parametric custom portfolios to a low of 3% for alternative assets and floating-rate income. In the third quarter, we had $2.7 billion of consolidated net inflows or $1.2 billion excluding Parametric overlay services.

The quarter's net flows were driven primarily by fixed-income mandates, open-end funds, and individual separate accounts. Annualized internal growth for the quarter was 2% as measured both in terms of consolidated managed assets and consolidated management fee revenue. That represents a sharp recovery from the prior quarter's annualized internal growth in managed assets of minus 7% and annualized internal growth in management fee revenue of minus 6%. Flow results generally improved as the quarter progressed, with July showing 13% annualized internal growth in managed assets or 4% excluding Parametric overlay services.

Looking at our third-quarter flow results by investment mandate reporting category. Fixed-income net inflows for the quarter totaled $4.5 billion, which equates to annualized internal growth of 29%. Within fixed income, the largest contributor to fund net inflows were our category-leading Eaton Vance short duration government income fund with net inflows of $1.7 billion; high-yield bond and municipal income mutual fund, each with approximately $650 million of net inflows; and emerging market local debt funds of $300 million of net inflows. Fixed-income institutional separate accounts saw over $1 billion of net inflows in the quarter led by cash management, high-yield bond, and emerging market local debt mandates.

For the fiscal year to date, managed assets in our emerging market local debt strategies have increased 54% to over $2.2 billion, reflecting strong performance of our two five-star-rated mutual funds in this category, Eaton Vance Emerging Markets Local Income Fund and the Eaton Vance Emerging Markets Debt Opportunities Funds, as well as initial success attracting intermediary and institutional clients in offshore markets. Turning to equities. Calvert Equity strategies contributed nearly $800 million of net inflows in the third quarter. For the fiscal year to date, flows into Calvert Equity strategies have totaled more than $2.7 billion, generating 27% annualized internal growth in managed assets for the nine months.

Calvert Equity Fund and Calvert small-cap fund, each contributed nearly $200 million of inflows in the third quarter, with Calvert Emerging Markets Fund and Calvert International Equity Fund together contributing nearly $175 million of additional net inflows in the quarter. EVM equity strategies generated approximately $200 million of net inflows in the third fiscal quarter, driven primarily by privately offered funds and our Eaton Vance Investment Counsel wealth management business. Atlanta Capital had equity net outflows of nearly $100 million in the third quarter as net inflows into their large-cap growth and select equity strategies were offset by $420 million of net outflows from the Eaton Vance Atlanta Capital SMID-Cap fund, our largest mutual fund, which has been closed to new investors since April 2018. With net outflows since the fund's closure now totaling approximately $1.6 billion, the fund's board of trustees voted earlier this week to reopen the fund to new investors effective September 30.

The portfolio team at Atlanta Capital views this as a particularly opportune time to invest in the types of high-quality stocks in which the fund specializes as these stocks have moved to attractive relative valuations. Parametric had $3.1 billion of net outflows from equity mandate in the third fiscal quarter, this reflects the termination of a single $1.7 billion institutional covered co-writing mandate and $1.6 billion of performance-related net outflows from Parametric Systematic Emerging Market Equity Strategies during the quarter. Parametric Systematic EME Strategies apply a modified equal weighting approach to country allocation that results in a structural underwriting to the China market, which has been a performance leader among the emerging markets over recent periods. At quarter-end, managed assets in Parametric Systematic EME Strategies consisted of $1.5 billion of U.S.

mutual fund AUM and $2.6 billion of offshore private fund and institutional separate account mandates. Turning to floating-rate income. Net outflows for the third fiscal quarter were just under $600 million, a significant improvement from nearly $3.2 billion of net outflows in the preceding quarter. After a steep downdraft in March, bank loan prices have now recovered most of the way back to pre-pandemic levels.

With the recovery in loan prices, activity in the CLO market has also resumed. In July, we successfully placed a new COO entity that closed earlier this week, which will contribute $450 million to our fourth-quarter net flows. In our alternative assets mandate reporting category, net outflows improved sequentially from nearly $700 million in the second fiscal quarter to less than $50 million in the third fiscal quarter. The improved flow results are attributable primarily to reduced net outflows from our two global macro absolute return strategies, for which combined net outflows were under $50 million in the third fiscal quarter versus over $650 million in the prior-year quarter.

Net flows into our global macro absolute return strategies and alternative asset mandates as a whole turned positive for the month of July. Parametric overlay services had $1.5 billion of net inflows in the third quarter of fiscal 2020, compared to $6.5 billion of net outflows in the prior fiscal quarter. Client's gain and loss contributed $750 million of net inflows in the third quarter versus $600 million in the prior quarter. Changes in positions held by continuing overlay clients contributed $750 million of net inflows for the third quarter, greatly improved from $7 billion of net outflows from continuing clients in the second fiscal quarter.

Consistent with prior market downturns, we have seen continuing clients increasingly put back on their overlay positions as markets have recovered. After three straight months of net reductions in positions held by continuing overlay clients, net flows from continuing clients swung to the positive in June and improved further in July. With a $4 billion pipeline of new overlay clients expected to onboard in the fourth quarter and the prospect of continuing net inflows from existing clients, our overlay services business is poised for a very strong close to the fiscal year. Parametric Custom Portfolios had $470 million of net outflows in the third fiscal quarter, which reflects continuing positive flow results for Custom Core Equity and laddered fixed-income individual separate accounts, offset by outflows from institutional and sub-advisory mandates.

What we sometimes refer to as Custom Beta individual separate accounts, which includes Parametric Custom Core Equity plus municipal and corporate bond ladders had $1.9 billion of net inflows for the quarter, which equates to 7% annualized internal growth in managed assets. The decline from $2.8 billion of net inflows and 9% internal growth annualized in the prior quarter primarily reflects the withdrawal by a single ultra-high net worth Custom Core client of $700 million to fund a major charitable contribution. Within Parametric Custom Portfolios, institutional and sub-advisory mandates and aggregate net outflows of $2.1 billion in the third quarter, which compares to $650 million of net outflows in the preceding quarter, these net outflows reflect negative flow results for the underlying third-party managed investment strategies unrelated to Parametric's role there as implementation manager. We continue to view customized individual separate accounts as a leading long-term trend in asset management and an open-ended market opportunity in which Parametric is positioned for continued dominance.

We recently announced the extension of the Parametric Custom Core franchise to include, for the first time, index-based fixed-income strategies. Parametric Custom Core fixed income seeks to provide advisors and their clients with exposure to the fixed-income markets they select combining the benefits of index-based portfolio construction, active credit oversight, and direct ownership of securities. Like Custom Core equity portfolios, Custom Core fixed income can be customized to reflect each client's individual responsible investment criteria and other desired portfolio tilts and exclusions to incorporate the client's pre-existing securities holdings and to harvest tax losses on a year-round systematic basis. Similar to our laddered bond separate accounts, Custom Core fixed-income portfolios combined a rules-based approach to portfolio construction with active credit oversight and available tax management.

Different from laddered bond portfolios, Custom Core fixed-income accounts seek to provide market exposures that approximate a client-specified fixed-income index or combination of indexes. Beyond Custom Core equities and fixed income, we see broadly ranging future opportunities for Parametric custom separate -- core accounts across multi-asset portfolios, applications combining active and passive management and customized individual target date and target risk portfolios. The future remains very bright for Parametric Custom Portfolios. In June, we announced the launch of Calvert ESG research leader strategies, a new series of equity separate account offerings for institutional and individual investors.

These strategies invest in the stocks of companies with leading environmental, social, and governance characteristics as determined by Calvert. Through partnership with Parametric tax-managed separate account versions of selected ESG research leader strategies are available to serve taxpaying investors. We also announced in June the creation of the Calvert Institute for responsible investment and affiliated research institute dedicated to driving positive change by advancing understanding and promoting best practices and responsible investing. Since we acquired the business assets of Calvert's predecessor company at the end of 2016, Calvert's managed assets have more than doubled, reaching $24.7 billion at the end of the third quarter of fiscal 2020.

With $3.4 billion of net inflows into Calvert Fund and separate accounts over the past nine months, Calvert has realized 23% annualized internal growth in managed assets for the fiscal year to date. Among dedicated responsibly invested mutual funds, Calvert is far and away the market leader in terms of net inflows over the past three and 12 months and ranks second currently in total assets under management. The strength of Calvert's brand as a long-term leader in responsible investing, combined with strong investment performance and Eaton Vance's leading distribution presence in the U.S. intermediary channel, has proven to be a winning formula for Calvert.

We see much more growth for Calvert in the quarters and years ahead. During the third quarter, we announced the signing of a definitive agreement to acquire the assets of WaterOak Advisors, a wealth management firm headquartered in Winter Park, Florida with approximately $2 billion of client assets under management. With a shared focus on high touch client service and a commitment to long-term relationships, a combination of WaterOak and Eaton Vance Investment Counsel will strengthen our position in private wealth management, which is an important strategic priority and allow us to develop a much larger business serving high net worth individuals and families in Florida and throughout the Southeast. Looking ahead to our fourth fiscal quarter, we are optimistic that the business momentum we saw building over the course of the third quarter will continue to accelerate.

We entered the fourth quarter with managed assets and run rate management fees well above third-quarter average levels. Net flows across our business have been quite strong over the month of August with overall net flows, both with and without Parametric overlay services, back in the range of what we saw in our first fiscal quarter before the pandemic hit. We have a robust pipeline of new business to fund in the fourth quarter, including the $450 million CLO that closed earlier this week, an $800 million institutional high-yield mandate scheduled to fund in early October, approximately $700 million of Custom Core equity separate accounts in the pipeline and over $5 billion of institutional portfolio overlay and LDI mandates scheduled to fund before the end of October. Reopening the Eaton Vance Atlanta Capital SMID-Cap fund, our largest mutual fund, to new investors after a two-and-a-half-year hiatus should also contribute positively to the favorable flow trends we expect to continue.

We believe there is considerable reason for optimism about the growth and performance of our business over the balance of fiscal 2020 and beyond. That concludes my prepared remarks. I will now turn the call over to Laurie.

Laurie Hylton -- Chief Financial Officer

Thank you, and good morning. As Tom described, we reported adjusted earnings per diluted share of $0.82 for the third quarter of fiscal 2020, up 3% from $0.80 in the second quarter of fiscal 2020 and down 7% from $0.88 in the third-quarter fiscal 2019. As you can see in Attachment 2 to our press release, adjustment earnings exceeded earnings under U.S. GAAP by $0.83 per diluted share in the third quarter of fiscal 2020, reflecting the reversal of the $100.5 million impairment loss recognized on the company's investment in our 49% owned affiliate Hexavest, the reversal of $8.5 million of net gains of consolidated investment entities and our other seed capital investments, the add-back of $1.6 million of management fees and expenses of consolidated investment entities and the reversal of $0.2 million of net excess tax benefits related to stock-based compensation awards.

Adjusted earnings exceeded earnings under U.S. GAAP by $0.15 per diluted share in the second quarter of fiscal 2020, reflecting a reversal of $16.8 million of net losses of consolidated investment entities and other seed capital investments, the add-back of $1.8 million of management fees and expenses of consolidated investment entities and reversal of $1.1 million of net excess tax benefits related to stock-based compensation awards. Earnings under U.S. GAAP exceeded adjusted earnings by $0.02 per diluted share in the third quarter of fiscal 2019, reflecting the reversal of $4.6 million of net gains of consolidated investment entities and other seed capital investments; the add-back of $2.3 million of management fees and expenses of consolidated investment entities; and the reversal of $0.6 million of net excess tax benefits related to stock-based compensation awards.

As Tom discussed in more detail, the outflows-driven decline in Hexavest managed assets and management fee revenue over recent months prompted the determination event in the third fiscal quarter. The company's equity method investment in Hexavest would likely other than temporarily impaired. Accordingly, the company recognized an impairment charge of $100.5 million in the quarter to reduce the carrying value of our investment in Hexavest to $32.7 million, which is estimated fair value based on the independent appraisal. As Tom previously noted, we continue to have faith in Hexavest's leadership and confidence in our investment team and approach.

As shown in Attachment 2 to our press release, adjusted operating income was up 7% sequentially and down 5% year over year. Our adjusted operating margin was 31.6% in the third quarter of fiscal 2020 compared to 30.5% in the second quarter of fiscal 2020 and 32.4% in the third-quarter fiscal 2019. Versus the prior quarter, average managed assets were up 1% and management fee revenue increased 4%. The increase in management fee revenue exceeded the increase in average managed assets primarily due to a 2% increase in our average annualized management fee rate from 29.7 basis points in the second quarter of fiscal 2020, the 30.3 basis points in the third quarter of fiscal 2020 and the impact of two more fee days in the third quarter.

Although average managed assets this quarter were up 3% from the same period last year, net management fee revenue was down 2%, reflecting a $0.05 decline in our average annualized management fee rate from 31.8 basis points in the third quarter of fiscal 2019 to 30.3 basis points in the third quarter of fiscal 2020. The decline in our average annualized management fee rate versus the comparative period last year was driven primarily by shifts in our business mix from higher fee to lower fee mandates. Performance-based fees, which are excluded from the calculation of our average management fee rates contributed $0.9 million, $2.5 million, and $0.1 million to revenue in the third-quarter fiscal 2020, the second quarter of fiscal 2020, and the third quarter of fiscal 2019, respectively. Management fees earned on consolidated investment entities, which are eliminated in consolidation and excluded from the calculation of our average management fee rates were $1.2 million, $1.3 million, and $1.8 million in the third quarter of fiscal 2020, the second-quarter fiscal 2020, and the third quarter of fiscal 2019, respectively.

Turning to expenses. Compensation expense increased 5% from the second-quarter fiscal 2020, reflecting higher operating income-based investment performance-based bonus accruals; higher stock-based compensation, primarily driven by additional expense recognized during the third quarter in connection with employee retirements; higher salaries associated with increases in headcount, primarily Parametric; the impact of two additional payroll days in the third quarter; and higher benefit expenses driven by $1.7 million insurance reimbursement recorded last quarter. These increases were partially offset by lower sales-based incentive compensation and a decrease in payroll taxes. Compared to the third quarter of fiscal 2019, compensation cost decreased 1%, reflecting lower operating income-based bonus accruals, lower sales-based incentive compensation, and lower severance costs.

These decreases were partially offset by a higher stock-based compensation and higher salaries and benefit expenses associated with increases in headcount, again, primarily Parametric. Non-compensation distribution-related costs, including distribution and service fee expenses and the amortization of deferred sales commissions, were substantially unchanged from the second quarter of fiscal 2020 as higher private fund service fee expenses and marketing support payments were offset by lower upfront sales commission expense. Year over year, non-compensation distribution-related costs decreased 7%, primarily reflecting lower distribution and service fee expenses for Class A and Class C mutual fund shares, driven by lower average managed assets, lower upfront sales commissions, lower discretionary marketing expenses, and lower intermediary marketing support payments. These decreases were partially offset by increases in service fee expenses and commission amortization for private funds.

Fund-related expenses decreased 12% sequentially and 2% year over year, reflecting lower fund expenses borne by the company, partially offset by higher sub-advisory fees due to an increase in average managed assets of sub-advised funds. Other operating expenses decreased 2% from the second quarter of fiscal 2020, primarily reflecting lower travel expenses, partially offset by an increase in other corporate expenses due to a one-time charge of $1.4 million related to a reimbursement to the company's sponsored funds recorded in the third quarter. Other operating expenses increased 5% from the third-quarter fiscal 2019, primarily reflecting increases in information technology spending, and we have mentioned the one-time charge, partially offset by lower travel expenses. Although we are continuing to invest in areas that are important for the future growth of the company, we are otherwise focused on tight expense management and reducing discretionary spending.

In this period of volatility, we continue to benefit greatly from the fact that more than 40% of our operating expenses are variable in nature, moving up and down with changes in operating income, managed assets, or sales results. Nonoperating income expense was up $105.7 million from the second quarter of fiscal 2020, primarily reflecting an $84.2 million positive change in net gains and losses and other investment income of consolidated sponsored funds and the company's investments in other sponsored strategies, a $21 million improvement in net income or expense of consolidated CLO entities and a $0.5 million decrease in interest expense. Nonoperating income was up $26.8 million from the third quarter of fiscal 2019, reflecting an $18.8 million increase in net gains and other investment income of consolidated sponsored funds and the company's investments in other sponsored strategies and an $8 million improvement in net income or expense of consolidated CLO entities. Turning to taxes.

Our U.S. GAAP effective tax rate was 22.6% in the third quarter of fiscal 2020, 45.3% in the second quarter of fiscal 2020, and 25.5% in the third quarter of fiscal 2019. The company's income tax provision was reduced by net excess tax benefits related to stock-based compensation awards totaling $0.2 million in the third quarter of fiscal 2020, $1.1 million in the second quarter of fiscal 2020, and $0.6 million in the third-quarter fiscal 2019. As shown in Attachment 2 to our press release, our calculations of adjusted net income and adjusted earnings per diluted share remove the impact of gains, losses and other investment income of consolidated and investment entities and other seed capital investments, add back the management fees and expenses of consolidated investment entities, exclude the effect of net excess tax benefits related to stock-based compensation awards and remove the impairment loss recognized on the company's investment in Hexavest.

On this basis, our adjusted effective tax rate was 27.1% in the third quarter of fiscal 2020, 24.9% in the second quarter of fiscal 2020, and 26.4% in the third-quarter fiscal 2019. On the same adjusted basis, we estimate that our quarterly effective tax rate for the balance of fiscal 2020 and for the fiscal year as a whole will range between 26.4% and 26.9%. In addition to the Hexavest impairment loss previously noted, equity net income of affiliates in the third quarter of fiscal 2020 includes $1 million of income earned from the company's investment in Hexavest, which was partially offset by $0.8 million of losses related to the company's investment in a private equity partnership. Substantially all of our equity net income of affiliates in the second quarter of fiscal 2020 and the third-quarter fiscal 2019 related to the company's investment in Hexavest.

We finished our third fiscal quarter holding $1 billion of cash, cash equivalents, and short-term debt securities and approximately $280.5 million in seed capital investments. We are carefully managing our cash flows during this period of heightened economic and market uncertainty to maintain our financial flexibility. During the third quarter of fiscal 2020, we used $41.2 million of corporate cash to pay the $0.375 per share quarterly dividend we declared at the end of our previous quarter. Our weighted average diluted shares outstanding were $111.7 million in the third quarter of fiscal 2020, flat sequentially and down 2% year over year, primarily reflecting a decrease in the dilutive effect of in-the-money options and unvested restricted stock awards due to lower market prices of the company's shares.

Fiscal discipline, tight management of discretionary spending, and maintaining a strong balance sheet continue to be top financial priorities for us in these unprecedented times. This concludes our prepared comments. At this point, we'd like to take any questions you may have.

Questions & Answers:

Operator

Thank you. [Operator instructions] Your first question comes from the line of Patrick Davitt with Autonomous Research. Patrick, your line is open.

Patrick Davitt -- Autonomous Research -- Analyst

Hey, good morning. Thank you. It looks like you had no share repurchase, I think, maybe for the first time ever, at least in my model. Could you speak to maybe the thinking around that after the share price decline? Was there some sort of unique restriction this quarter? And how should we think about that going forward?

Laurie Hylton -- Chief Financial Officer

Hi. It's Laurie. As we were looking at this quarter and last quarter, it really has been top-of-mind for us to ensure that we've got financial flexibility, particularly in terms of our liquidity. And I think as we mentioned last quarter, given everything that's happening on the global stage, we thought it was prudent to cut back on our share repurchases, and we just continue to look at it quarter by quarter.

But again, we're really just trying to ensure that we've got the liquidity necessary to continue to grow the business.

Patrick Davitt -- Autonomous Research -- Analyst

OK. Thanks. And then also just a quick follow-up. The Parametric Emerging Market strategy you called out with some performance-related outflows.

I think you said there was $1.5 billion and $2.6 billion left in that bucket. Should we take that to mean that you're worried that that might be AUM at risk given the performance issues?

Tom Faust -- Chairman and Chief Executive Officer

I think there's a reasonable chance that unless performance improves, that it's an active strategy that competes against other attractive strategies. The nature of our business is if you can't deliver performance that exceeds benchmarks and peer group over time, it's reasonable to expect assets to come down. We have seen quite a bit of net outflows from that strategy. We think there's likely to be more stickiness to the assets on the mutual fund side, perhaps, than the nonmutual fund business.

But certainly, for modeling purposes, we would assume that outflows there will continue. Though, ultimately, we're constrained by the amount of outflows by the assets what we have, which is down to just over $4 billion currently.

Operator

Our next question comes from the line of Craig Siegenthaler with Credit Suisse. Craig, your line is open.

Craig Siegenthaler -- Credit Suisse -- Analyst

Thank you. Good morning, everyone. I'm interested in an update on what you're seeing on the competitive landscape at Parametric and Custom Core equity, and I'm especially interested in your comments around direct indexing.

Tom Faust -- Chairman and Chief Executive Officer

Thanks, Greg. So there's quite a bit of, I guess, you would say, noise. There have been announcements of a number of potential competitors that have interest in the space, public comments. In many ways, it has been gratifying that people acknowledge that this is an area where that provides value-added for clients and many people perceive to have growth potential.

In terms of what's happening in the marketplace as opposed to what we're hearing in announcements, there really hasn't been a meaningful change in competitive position. There's no new competitor that we're aware of that's taking significant share. We're not losing business being replaced by someone else. So there's no evidence that any of the announcements are translating so far into changes in the competitive dynamic.

This is a business that we and many others expect will grow quite substantially over coming quarters and years. It's not a surprise that others will try and compete in this business given the growth profile that is there. I would say that our experience, which goes back, now several decades, is that this is a hard business. It's not a business for dabblers, that there's a real commitment required to invest in technology, to invest in service, and to invest in distribution to gain access across the markets.

So far, there haven't been any competitors that have emerged that we're worried about, who check all those boxes in terms of level of commitment and demonstrated expertise and technology and service and have similar distribution to us. But we think it will be a much bigger market. It's reasonable that there'll be more competitors. But we think that the position that Parametric has there is very solid, very strong, and very secure.

Craig Siegenthaler -- Credit Suisse -- Analyst

Thanks, Tom. And just a follow-up here. If you do see an increase in competition in direct indexing and new entrants offer a comparable product at lower price points, can you comment your ability to reduce pricing below the mid-teens, which is where I think the blended fee rate is today and still generate attractive margins?

Tom Faust -- Chairman and Chief Executive Officer

Certainly, we have the ability to respond selectively to competitors that compete on price. We will go toe to toe with anyone in terms of the quality and the value proposition that we offer as a leader in customized indexing. Competition in this space is not new throughout the time that we've been growing our custom indexing business. There have been other players in the market.

The profile of those competitors really hasn't changed. The nature of the competition really hasn't changed. What has happened is that as the market has grown, its visibility has increased and we're seeing more conversation. But in terms of what's happening in the marketplace, we continue to compete as appropriately on price.

We see nothing to suggest that we'll see wholesale reductions in average fee rates for this business, but we're certainly making the investments in technology and service and systems that will allow us to support a much bigger business and that ultimately will allow us to lower our operating costs so that we can achieve attractive margins even at potentially lower average fee rates.

Craig Siegenthaler -- Credit Suisse -- Analyst

Thank you.

Operator

Your next question comes from the line of Dan Fannon with Jefferies. Dan, your line is open.

Dan Fannon -- Jefferies -- Analyst

Thanks. Just to follow up on kind of the flows and the momentum you cited heading into the fourth quarter. If you could just clarify, again, I think you said the total number would be similar to the first quarter. I think either including or excluding some of the lower fee stuff, but just want to clarify that.

And then also, does that include some of the mandates you talked about? Or would that -- just trying to think about what still hasn't funded versus what you're saying has happened in August.

Tom Faust -- Chairman and Chief Executive Officer

Yeah. Let me clarify, Dan. So the comment, what I was trying to make is that trying to say is that for our August to date, and this would not include any of the pipeline things that I talk about, we're seeing quite strong flows that if you exclude the Parametric overlay service business puts us, we think, on pace for the same range of lows that we saw in the first quarter. Again, that's based on quarter-to-date results.

Through yesterday or through the day before yesterday, get, that is in the range of about, I think, $1.7 billion for our non-Parametric overlay business. You multiply that by three to account for the fact that we're less than a third of the way through the quarter, and that gets you sort of in the ballpark, the $5 billion of non-overlay net flows that we had in the first quarter. Momentum is good. That includes strong sales of fixed income, continuing positive flows for equity, positive flows for floating-rate income, positive custom portfolios.

As I mentioned, we're expecting, on top of that, a quite strong quarter for the overlay services business where we've got meaningful amounts of a couple of billion dollars plus of net inflows for the quarter to date, plus a quite robust pipeline of new business that we're expecting to fund. All these forecasts should be taken with a grain of salt, we're only a third of the way through the quarter, things can happen as we saw back in March. But certainly, we're on track for a quite strong fourth quarter in terms of flows supported by an excellent first month of that quarter and a visible pipeline of new opportunities that we think will likely support continuing flow momentum through the balance of this month and then through September and into the end of October and the end of the fiscal year.

Dan Fannon -- Jefferies -- Analyst

Great. That's helpful. And then, Laurie, just with regards to expenses and kind of the outlook. Clearly, with the revenue side looking better based on where markets and AUMs sit.

As we think about going into next quarter, is margin expansion from here is still reasonable given what's happening with revenue and then still some kind of operational leverage potential on some of the nondiscretionary spending side?

Laurie Hylton -- Chief Financial Officer

I would certainly say there's always the possibility. I hesitate just given the volatility that we see in the markets to put money on anything at this point, but I do think that we're very comfortable in thinking that the year is going to be in this 31% range. So I would not necessarily anticipate a significant uptick in the fourth quarter, but I do think we're very comfortable in the range that we're in.

Dan Fannon -- Jefferies -- Analyst

Thank you.

Operator

Our next question comes from the line of Ken Worthington with JP Morgan. Ken, your line is open.

Ken Worthington -- J.P. Morgan -- Analyst

Hi. Good morning and thanks for taking my question. So I'll combine everything into one. Just following up on the equity outflows this quarter, it seemed, to some extent, that the weakness this quarter was as much a function of weaker gross sales versus the last couple of quarters as it was for the higher gross outflows.

So can you flesh out, if you agree, the gross sales side of the equation as well? And for the follow-up on the outflows, you mentioned, I believe it was $1.7 billion of covered calls and the $1.6 billion of the systematic. For the covered call strategy, how do those strategies typically do in this type of market? And maybe how much is left there? And on the systematic side, you said it was performance-based. I believe you called out China as the driver. Are there other issues besides exposure to China, or was that really all of the issue?

Tom Faust -- Chairman and Chief Executive Officer

OK. I think I can get, at least, most of that. So starting with emerging market equities. Systematic strategy, so they don't make market calls.

So think about this in the broad category of things as a smart beta or multifactor strategy. The premise of the fund is value-added through diversification and rebalancing the philosophy is a modified equal waiting approach to country allocation and alpha generation by rebalancing into underperforming countries. That worked for a very long time. It has not worked recently simply because the China market has come to dominate the emerging market indexes, both in terms of weighting, but also in terms of contribution to performance.

So a strategy that, by design, is under way to the largest markets. In this case, China is very much hand strong in trying to perform in market environments, which we've been in, where you have sustained leadership of those largest countries in the index. So we've had performance-related outflows. I guess you would say, in addition to the country allocation, given the rebalancing nature of the approach we take, there's an anti-momentum bias to the strategy that also has not helped during this period.

But the outflows are, we think, going to abate highlighted that we're at $4 billion in assets, I think peak assets in this strategy, we're in the range of $20 billion. So it's mostly behind us in terms of the outflows with only a remaining $4 billion left. How quickly we see that go away? I think it's anyone's guess, but we're certainly expecting, based on performance that we've seen as of current periods, still underperforming. So we think it's reasonable to expect that outflows will continue.

A second part of the question, related to the covered call writing business and what Parametric refers to as volatility risk premium strategy that is monetizing the alpha that's created from the fact that options typically sell at a premium where the implied volatility is typically higher than the realized volatility. Those strategies generally performed well during trending markets when you collect your premium, but you don't get called away from the upside or have to buy in a position to avoid getting called away on the upside. When they don't perform particularly well as in the V-type markets where there's a sharp upturn, which obviously is what we had in the April-May period after the lows in March, so it's not surprising that we would see pressure on these strategies in market environments like this. Covered call writing is essentially trying to capture this premium that's frequently observed in the pricing of options, but it comes potentially at the cost of capping the upside in a sharply rising market.

And when that happens, clients are prone to be disappointed. After some period of clients taking off positions, I think generally, we're in a mode of sort of neutrality to positive flows for our covered call writing business. So I think that covers the second part. The third, which I don't really have information in front of me, so I'm going to have to guess at this, but did the quarterly flow results for equities reflect more a decline in gross sales or more increase in redemptions? I would say -- I guess I would maybe turn the question around, I guess, and say, most of our business, the Calvert business had positive flows.

The EVM equity business had positive flows. The Atlanta Capital business, excluding the big fund there that's close to new investors, had positive flows. I would turn it around to say that the outflows that we saw in the equity category were very, very concentrated in the two things that I called out at Parametric, that being the covered call writing, the big institutional account that was lost there, the $1.7 billion; the emerging market equity strategies and then the outflows from the Atlanta capital SMID-Cap fund, which was over $400 million. So in general, we feel our equity flows are good.

A flash report through yesterday showed positive equity flows in the fourth quarter. And we certainly feel good about our ability to continue to grow in equities, subject to continuing pressure on that emerging market equity franchise that weighs against that.

Ken Worthington -- J.P. Morgan -- Analyst

Awesome. Thank you very much.

Operator

Our next question comes from the line of Bill Katz with Citigroup. Bill, your line is open.

Bill Katz -- Citi -- Analyst

OK. Thanks very much. Maybe just two-parter maybe for Laurie. Just sort of curious, in terms of capital management, what milestones should we be looking at macro-wise or otherwise to think about the reengagement of repurchase given your free cash flow? And then, Tom, just a big-picture perspective, as you're dialoguing with both the retail and institutional gatekeepers, what are you hearing in terms of allocation decisions just given the V-shaped recovery of equity and credit markets? Thank you.

Laurie Hylton -- Chief Financial Officer

Bill, it's Laurie.

Tom Faust -- Chairman and Chief Executive Officer

Laurie, you want to go first?

Laurie Hylton -- Chief Financial Officer

Yeah, I can go first. We really don't have any markers that I would say to look toward. We don't have a program for share repurchases. It's a discretionary decision.

We have a small committee that thinks about this every quarter. And I think that we'll be considering all the possible inputs as we move out of our blackout. So more to come on that, but nothing specific to look for in terms of markers.

Tom Faust -- Chairman and Chief Executive Officer

Bill, in terms of markets and where we're headed, I mean, first, I'm generally not too involved in those decisions with gatekeepers about asset allocation. My own market view is that the markets will likely continue to grind their way higher given what we see as likely to be continuing positive news on the pandemic, particularly from a therapeutic and vaccine standpoint, more so than public health and the likelihood that the economy will continue to be positive. Certainly, one of the things we're watching carefully is U.S. election and what that might imply for future tax rates, future regulatory, and spending initiatives.

I think as most of our listeners are aware, we have a large business serving taxpaying investors, which represent some version of tax-managed strategies represent over 40% of our assets, including municipal bond funds and tax-managed equities. We're not exactly sure what's going to happen, but we certainly think that there's a reasonable prospect that following the election, we could see an increase in tax rates, which could be a significant positive for that business.

Bill Katz -- Citi -- Analyst

OK. Thank you.

Operator

Your next question comes from the line of Brian Bedell with Deutsche Bank. Brian, your line is open.

Brian Bedell -- Deutsche Bank -- Analyst

Great. Thanks. Good morning. A lot of good questions and answers on the Parametric.

Maybe if I could just add one. Tom, I guess what do you make of the importance of fractional share accounting in the custom indexing business in terms of the potential competitor responses down the road? And again, going back to, obviously, your business has performed very well, and you have a leading position in this business. But I mean, going forward, if it's not competing on pricing, what other growth angles, within the Parametric business, I guess, would you point to that, would keep your position strong there?

Tom Faust -- Chairman and Chief Executive Officer

Yeah. Thanks, Brian. We compete primarily in high net worth market for Parametric custom portfolios. For Custom Core equities, the account minimum at most places, I believe, is $250,000.

So the impact of fractional shares for someone that's putting to work $250,000 is pretty minimal. There is the opportunity with fractional shares, and you've been reading about these, to do less customized or even non-customized direct indexing-based strategies, which, to us, is not a particularly interesting product or interesting market. Our perspective is that the value here is in the customization. And the cost of delivering customization is the service that's required and to deliver customized accounts and high levels of service at the kinds of fee rates we're talking about and the account minimums we're talking about is hard.

And we are making investments in technology to put us in a position to continue to be a leader in doing that. But I would say broadly the impact of fractional shares, while it will make it easier for us and other competitors potentially to go down market, the real name of the game here is customization. The primary value-added for most investors, not all, but most is tax efficiency, which is a concern primarily at higher tax rates. We do see the business evolving in significant ways.

I highlighted the fact that we've introduced Custom Core index products on the fixed-income side. We certainly see lots of opportunity for product innovation down the road in terms of enhancing the features that we offer, expanding the array of capabilities so that it's not just index-based, but it's index plus active. It's not just equity or not just fixed income but a combination of both. And then very interesting applications potentially down the road in terms of target date or target risk, all customized to the individual.

So we think there's lots of room here for lots of different ideas. The value-added that we provide, again, is customization and service, primarily for higher net worth investors, primarily with a significant value-add being taxed. And some of the things that we're hearing about really just not relevant to that market and that market opportunity as we see it.

Brian Bedell -- Deutsche Bank -- Analyst

OK. Great. That's great color. And then maybe a follow-up.

Maybe just, Tom, your perspective on the active ETF industry now that we've got a number of ETFs live in the industry. I know you filed an amendment for the Clearhedge strategy with the SEC. Maybe just a comment on, I guess, the status on that and how you think that maybe conversations with potential users of the Clearhedge strategy and then, broadly, the potential for you guys to license active ETFs or create them under a proxy portfolio structure for your own funds.

Tom Faust -- Chairman and Chief Executive Officer

So we remain very interested, very close to this space, as you point out. We did file a second amended application with the SEC for our Clearhedge method of what we call portfolio-protected ETFs, some we call less transparent active ETFs. We filed that last month. You can read that as indicative of positive constructive dialogue with the SEC staff.

We certainly can't predict when or ultimately what they will decide, but we certainly feel good about the dialogue that we're engaged in there and are hopeful we'll ultimately get a positive result. The competitive landscape is really just beginning to emerge. I think there's five different concepts that have been approved by the SEC. We hope to be the sixth.

Our business model here would include licensing our technology to others. We hope to compete on the basis of offering the highest level of assurance of strong secondary market trading consistent with not having to disclose portfolio holdings or significant representative proxy portfolio on a daily basis. So we think we've got a very competitive mousetrap. This market is starting to develop based on the assets and flow numbers that I've seen, and we certainly want to have a place in that.

Like the other approved applications, our applications, at least initially, is limited to cash and exchange-traded securities that trade during U.S. market hours. So think of that as U.S. equities and U.S.

ETFs and Canadian and perhaps other markets that trade during the same time frame as the U.S. So it would be limited in that respect initially, which we think, frankly, quite reasonably, the SEC says, let's see how this works for this asset class before we consider other asset classes. But we're very hopeful, very optimistic that, ultimately, that this class of products and our application, our technology, in particular, we'll see application across all asset classes. And so we continue to be very much optimistic about the future of actively managed exchange-traded products based on the potential enhancement in operating efficiency, trading convenience and tax efficiency versus ETFs.

And so while we have a long heritage in the mutual fund industry, we are very committed to the development of customized individual separate accounts as an enhanced way for investors to invest in an array of strategies and then similarly invested in less transparent ETFs or portfolio protected ETFs as a way to do similar things through a fund vehicle with structural advantages versus a traditional mutual fund concept.

Brian Bedell -- Deutsche Bank -- Analyst

And just for licensing your own funds, would you be using -- would you more likely use a proxy model that's out there already or, say, the Precidian model and then apply the Clearhedge to the progress?

Tom Faust -- Chairman and Chief Executive Officer

No. We would be using our model as an alternative to the -- so think of the Clearhedge as a sixth approach. It's not something that would be an add-on to one of the other approaches.

Brian Bedell -- Deutsche Bank -- Analyst

Got it. Thank you.

Operator

Our next question comes from the line of Mike Carrier with Bank of America. Mike, your line is open.

Mike Carrier -- Bank of America Merrill Lynch -- Analyst

Great. Thanks for taking the questions. Tom, overall, the flow outlook looks promising. I just wanted to get an update on how you're seeing demand shift in the floating rate category and then if there was anything unusual on the strength of the fixed income this quarter.

And then just a small clarification or follow-up. I think you mentioned one or two funds reopening. I caught one was Atlanta Capital, but I wasn't sure if there was another one that you mentioned as well. Thanks.

Tom Faust -- Chairman and Chief Executive Officer

Yeah. So, no, the only fund we have that's reopening is the Atlanta Capital SMID-Cap fund, which is an important milestone for us. It is our largest and, I guess, by that measure, most popular fund and it's got a real strong following. And because it's been closed, we've seen fairly significant net outflows.

I think I said $420 million in the quarter. So once that's reopened, I would certainly hope, at a minimum, we can stop the net outflows and potentially get that fund back into a growth mode again. It's not an open-ended opportunity. We're potentially looking at closing it again if we get significant net inflows.

But at a minimum, we're hoping to abate the outflows there. In terms of bank loans, it's an interesting position we're in currently. I just said modestly to the positive in terms of our bank loan flows for the month of August to date through Monday of this week. But it's pretty small, positive, but closer to zero than some meaningful number.

That does not include the CLO that I talked about as being priced this week. So we're thinking that we've kind of bottomed out. We had a very rough quarter in the second quarter in terms of bank loan flows. Yields here are pretty attractive.

And I just checked this morning, the yield on our unlevered floating-rate fund is about 3.6%. The modestly levered version is at 4.4% and the version that has an allocation to high-yield is at 3.8%. Those are pretty attractive yields for a floating rate product in today's marketplace. Obviously, you got to be comfortable taking credit risk because that's a component of this asset classes, these are below-investment-grade securities.

But if people are generally getting comfortable that we've seen the worst in the economy and you look at what kinds of yields are available in other instruments and you start to worry, at least some people do worry about the possibility that loan rates could be moving up and we may have hit the bottom in terms of where those are, you start to build an environment in which floating-rate bank loans could be, again, an attractive asset class. Our history in this business, which goes back to 1989, is that it's a business of cyclical growth in which our pattern has been over market cycles. We typically hit a new high in assets and then people's rate expectations change, and we see outflows or people get concerned about credit and we see outflows. But we see nothing about our industry position or about the fundamental attractiveness of the asset class to suggest that we can't, again, regain the former highs in managed assets, which we're in the, I think, mid-40s of billions of dollars.

So that's not going to happen overnight, but we certainly think that we're in the bottoming stage or we're maybe coming out of the bottoming stage and are hopeful that we'll see an improvement in flows. But it's not happening yet. The good flows that we've had for August have been much more driven by fixed income as opposed to floating-rate income with continued very healthy flows for our short duration government income fund or our high-yield strategies and for our muni strategies being the primary drivers of our income products flows. The nice thing about bank loans, it's not a negative currently in the same way that it was a significant negative in the second quarter and a modest negative in the third quarter.

Operator

Our next question comes from the line of Robert Lee with KBW. Robert, your line is open.

Jeff Drezner -- KBW -- Analyst

Hi. This is actually Jeff Drezner on for Rob Lee. I had a question. I was curious if you can give us an update on the potential acquisitions, if you see things accelerating, and where your focus might be on that.

Tom Faust -- Chairman and Chief Executive Officer

Yes. So we highlighted in my prepared remarks that we're -- we announced an acquisition of a $2 billion wealth manager in Florida called WaterOak Advisors. We announced that, I think, last month and would hope to close that before the end of the year. You should take that as a signal that we continue to be interested in expanding in wealth management.

We're approaching $10 billion in managed assets there, including WaterOak after that transaction is closed, which is a meaningful sized competitor in the wealth management space and think that we have a lot to offer there, and we'll look for other ways to grow there. And other things that we find potentially interesting and where we continue to have conversations include private credit, which we view as a potentially highly complementary to our strong industry position and capabilities in the public credit markets through bank loans and high-yield bonds. So those are maybe two areas of focus. We continue to look for opportunities to grow our platform in responsible investing, particularly if we can do that outside the United States.

Calvert is, today, primarily a U.S. brand that in an ideal world we could grow our presence in responsible investing outside the United States. So those are some of the things we're looking at.

Jeff Drezner -- KBW -- Analyst

Great. Thanks, Tom. And then just another one on the muni ladder. Just in terms of the low rate environment, how do you see the demand for those and the outlook?

Tom Faust -- Chairman and Chief Executive Officer

That is, frankly, a challenge that for investment-grade muni ladders, there's just not a whole lot of yield available at current interest rates. One of the things we've been looking to do and are in the process of potentially bringing to market is a separate account product that includes a sleeve allocated to high-yield muni issuance or corporate issuance for corporate ladders that brings up the yield and does it in a diversified and appropriately diversified way. So it would be owning as a part of a ladder or a separate account structure, a sleeve dedicated to a diversified portfolio of higher-yielding assets with the goal to bring up the overall income level for the portfolio in a managed, controlled-risk way.

Jeff Drezner -- KBW -- Analyst

Great. Thanks for the color.

Operator

Our final question comes from the line of Glenn Schorr with Evercore. Glenn, your line is open.

Glenn Schorr -- Evercore ISI -- Analyst

Thanks very much. Tom, I wanted to ask a little follow-up on your comments earlier given tax-managed importance to your overall AUM base. And I'm with you, between the election and the huge stimulus, there is a good chance tax rates are going up at some point. So the question is, what can you do to prepare either educating the clients, educating the wealth management channel? And is the post-election tax cuts any indication in reverse of what we might see? How big of an opportunity do you see a higher tax rate environment across your platform?

Tom Faust -- Chairman and Chief Executive Officer

Yeah. So we've gone through this a few times. We've had a focus on tax-managed equities and muni bonds for several decades now, and so we've seen multiple cycles of rates going up and rates going down. So we have some historical perspective on how this might play out.

There is certainly a lot of interest in the topic, and it's been a major focus of our communication efforts to talk about the importance of investment taxes. For a number of years, we used to do surveys of investors asking about their thoughts on investment taxes. And the results were always very consistent, which is that many investors appreciate the importance of taxes, but very few of them would say they understand what's involved. And increasingly, they look to their financial advisors as a source of information and guidance on tax-efficient investing and that, we think, is a great way for advisors to work with clients and add value is providing information and solutions to help address concerns about taxes that they're going to be paying.

So we've done a lot of that over the years. If you go to our website and look at our marketing materials, we have a fair bit on there about taxes. We have a calculator, which you enter where you live and what your filing status is and what your taxable income is, and you can calculate what your current tax rate is. We're looking at expanding that so that you can do a pro forma tax rate based on assumptions about where tax rates go.

But for us, it's a great way to get in front of advisors to help them educate their clients and demonstrate their expertise on something where clients know they need help on, know they need advice on. Exactly how that plays out for us in terms of what products that is or how our product lineup might change as a result of that. I think it's still way too early to determine what that might look like. But certainly, superficially, municipal bonds becoming more attractive at higher interest rates, Parametric Custom Portfolios, tax-managed investing generally becomes more attractive at higher rates.

And that's very much a focus of our sales and marketing teams going into the election is to try and help position advisors to provide good advice for their clients in that environment.

Operator

This concludes our question-and-answer session. I will now turn the call back over to Eric Senay for closing remarks.

Eric Senay -- Treasurer and Director of Investor Relations

Thank you. And I want to thank you for participating in our earning call today. And we hope everyone will stay safe and healthy. Thank you and have a good day.

Operator

[Operator signoff]

Duration: 71 minutes

Call participants:

Eric Senay -- Treasurer and Director of Investor Relations

Tom Faust -- Chairman and Chief Executive Officer

Laurie Hylton -- Chief Financial Officer

Patrick Davitt -- Autonomous Research -- Analyst

Craig Siegenthaler -- Credit Suisse -- Analyst

Dan Fannon -- Jefferies -- Analyst

Ken Worthington -- J.P. Morgan -- Analyst

Bill Katz -- Citi -- Analyst

Brian Bedell -- Deutsche Bank -- Analyst

Mike Carrier -- Bank of America Merrill Lynch -- Analyst

Jeff Drezner -- KBW -- Analyst

Glenn Schorr -- Evercore ISI -- Analyst

More EV analysis

All earnings call transcripts