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Welcome to the Franklin Templeton's Earnings Conference Call for the year ended September 30, 2026. Hello. My name is Shamali, and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions]

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

Good morning, and thank you for joining us today to discuss our quarterly and fiscal year results. Statements made on this conference call regarding Franklin Templeton, Inc., which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that can cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings.

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

Thank you, Selene. Welcome, everyone, and thank you for joining us to discuss Franklin Templeton's Fourth Quarter and Fiscal Year 2026 results. I'm joined today by Matt Nicholls, our Co-President and CFO; and Daniel Gamba, our Co-President and Chief Commercial Officer. Today, as outlined in our investor presentation, I'll discuss our fourth quarter and full year results and then give an update on the progress we've made in the second year of our 5-year plan, highlighting key drivers of growth across our business. Matt will then review our financial performance and guidance, and we'll take your questions.

Fiscal 2026 was a year of significant progress for Franklin Templeton. The investments we've made to diversify our business, strengthen our capabilities and better serve clients are translating into measurable results. We ended the fiscal year with $1.8 trillion in assets under management and generated $84.1 billion in long-term net inflows, representing an improvement of more than $181 billion from fiscal 2025 and an annual long-term organic growth rate of 5.3%.

Importantly, we generated positive long-term net flows in every quarter across every region and in both retail and institutional channels. We also delivered meaningful improvement in profitability with adjusted operating income increasing 23% and our adjusted operating margin expanding 350 basis points to 28%. These results demonstrate the progress we're making in the second year of our 5-year strategic plan. We are generating broader organic growth, deepening client relationships and building a more diversified, efficient and scalable global business.

Our diversification is an important competitive advantage. With investment capabilities spanning public and private markets, a balanced mix of retail and institutional clients and a global distribution platform, we have multiple sources of growth. As clients increasingly seek integrated solutions rather than individual products, our One Franklin Templeton approach allows us to bring together the expertise of our distinct investment groups across public and private markets, offer greater choice of investment vehicles and customized solutions and leverage our global distribution network to serve clients across regions and channels. This more integrated approach strengthens client relationships, creates new opportunities for organic growth and improves operational efficiency, positioning us to build a more scalable and profitable business that delivers long-term value for clients and shareholders.

Turning to AUM and flows on Slide 11. Long-term inflows increased 38% to $474 billion for the fiscal year, reflecting strong client demand across public and private markets. We ended the year with continued momentum. Fourth quarter long-term net inflows were $20.8 billion with positive contributions from equity, alternatives and multi-asset. Our institutional pipeline of won-but-unfunded mandates remains strong at $22 billion at year-end, diversified across investment groups and asset classes.

Turning to flows by asset class on Slides 12 and 13. Starting with equity, AUM reached a record $764 billion with $21.1 billion in net inflows for the year. Demand spanned large-cap value, large-cap core, international equity, ETFs, infrastructure and sector strategies. Fourth quarter equity net inflows doubled sequentially to $4 billion. Fixed income AUM reached $428 billion, while full year net outflows moderated to approximately $700 million. We continue to see demand for multi-sector, municipal and stable value strategies.

Turning to Slide 13. Alternatives and multi-asset led organic growth generating a combined $63.7 billion in net inflows for the year and $17.4 billion in the fourth quarter. This reflects sustained demand for private markets, diversified income strategies and integrated investment solutions. Earlier this week, we reported preliminary October AUM of $1.81 trillion with long-term net inflows of $3 billion and the benefit of markets. That's our 11th straight month of positive long-term net flows and with a $22 billion pipeline of won but unfunded mandates. We enter fiscal 2027 with good momentum.

Our global reach continues to be an important competitive advantage, allowing us to connect investment capabilities from across Franklin and Templeton with client opportunities around the world. International AUM reached $523 billion with $29 billion in long-term net inflows during fiscal 2026. Flows were positive across the U.S., EMEA, APAC and the Americas, reflecting the strength of our global distribution and local relationships. The successful dual listing of the National Investment Fund of the Republic of Uzbekistan on the London and Tashkent Stock Exchanges highlights our leadership in emerging markets and our ability to partner with governments to develop capital markets and manage strategic mandates. Taken together, these results reflect broader, more consistent sources of organic growth across asset classes, client segments and geographies.

Turning to Page 10. Investment performance remains fundamental to everything we do. In public markets, long-term performance remains competitive with 50% or more of our mutual funds and ETF AUM outperforming peer medians across the 1-, 3-, 5- and 10-year periods. In our strategy composites, 55% or more of AUM outperformed benchmarks across the 3-, 5- and 10-year periods. These results reflect the strength of our investment capabilities and our continued focus on delivering strong outcomes for clients. An important part of our strategy is building platforms while preserving the distinct expertise of our investment groups.

In public markets, we continued to simplify our investment management platform. This year, we combined Franklin Equity Group, Mutual Series and Brandywine Global's equity capabilities under Franklin Equity, establishing a platform with approximately $200 billion in AUM. Similarly, the alignment of our fixed income and cash management capabilities under Franklin Templeton Fixed Income, including Western Asset, creates a global platform with over $500 billion in AUM. These changes deepen our research and portfolio risk management resources, strengthen collaboration and broaden opportunities for talent development. Since fiscal 2024, we have also refined our product lineup to focus on scalable high-demand strategies, thoughtfully retiring certain brands and integrating investment capabilities where it made sense.

Turning to our 5-year strategic plan. We completed year 2 on track or ahead of our original targets. With several key growth areas ahead of plan, we are raising our fiscal 2029 goals for private market fundraising, ETFs, Canvas and adjusted operating margin.

Turning to Slide 20. Franklin Templeton has established a leading position in alternatives, one of our most important long-term growth opportunities. Alternatives are projected to represent approximately 54% of global asset management industry revenues by 2030, driven by growing institutional demand and the expansion of private markets into wealth management and retirement.

Franklin Templeton is well positioned to capture this opportunity. Alternative AUM reached a record $305 billion at year-end, inclusive of $17 billion in realizations and distributions during the year. We fundraised $48.7 billion across alternatives in fiscal 2026, including $43.2 billion in private markets, diversified across secondary private equity, alternative credit, real estate and venture strategies. Since fiscal 2024, we have raised approximately $66 billion, achieving roughly 2/3 of our original 5-year goal in just 2 years.

Given this momentum, we are increasing our fiscal 2029 private markets fundraising target to $150 billion from our original target of $100 billion established 2 years ago. Beyond the growth opportunity, private markets further diversifies our business, expands our capabilities and provides longer duration capital and recurring revenue streams that complement our public markets franchise and strengthen our earnings profile. This year, we have also continued to expand and globalize our alternatives businesses through targeted acquisitions and strategic investments, strengthening our capabilities in alternative credit and real estate.

In alternative credit, we completed the acquisition of Apera Asset Management, expanding our European direct lending capabilities. Alternative credit AUM has now surpassed $100 billion. In October, we also broadened Benefit Street Partners' asset-backed finance platform through our transaction with Encina Lender Finance and added its investment team and an initial seed portfolio of approximately $480 million in commitments.

In real estate, through Clarion Partners, we announced the acquisition of a majority stake in Stoneshield Capital, a European real assets manager, which is expected to triple Clarion's European AUM to approximately $13 billion and bring pro forma real estate AUM to $90 billion.

A further notable opportunity is democratizing private markets through the wealth management channel. Private wealth is projected to account for approximately 25% of alternative asset expansion over the next decade. Franklin Templeton is well positioned to capture our share of this growth by leveraging our scale, global distribution partnerships and product innovation to help lead the next era of alternative investing. Wealth clients contributed 22% of our private markets fundraising in fiscal 2026, and our Franklin Templeton Private Markets Evergreen range reached $9.7 billion in AUM.

We are also introducing new ways for clients to access our capabilities, including private markets model portfolios with Corastone and the launch of our inaugural $1.5 billion collateralized fund obligation.

Retirement represents another significant long-term opportunity for private markets. Franklin Templeton enters this evolving market from a position of strength, managing approximately $460 billion in retirement assets, including $139 billion in defined contribution. Building on this foundation, we are expanding blended public and private market solutions across target date, multi-asset credit and infrastructure strategies.

Turning to distribution on Slide 21. Our global reach and breadth of investment capabilities are important competitive advantages. With clients in over 150 countries, we deliver the expertise of our distinct investment teams through the investment vehicles and solutions of their choice. Vehicle diversification continues to be a key driver of organic growth with record net inflows across retail SMAs, Canvas and ETFs, growing AUM from the prior year by 19%, 100% and 73%, respectively. These results reflect growing client demand for greater choice, customization and tax-efficient investment solutions.

Franklin Templeton is a leader in retail SMAs. Our retail SMA business offers more than 200 investment strategies and has grown at a 20% compound annual rate since fiscal 2023. AUM reached a record $196 billion with $15.8 billion in net inflows this year. The demand for personalized, tax-efficient investment solutions continues to grow. Industry SMA assets have reached $5.4 trillion with unified managed accounts projected to grow 89% by 2030.

Within this market, Canvas continues to exceed our growth expectations. Canvas AUM has grown nearly sevenfold since fiscal 2023 and doubled over the past year to $32.6 billion, generating $13.2 billion in net inflows. We have expanded Canvas across broker-dealers, RIAs and family offices to more than 235 distribution partners, up from 67 in fiscal 2023. Financial advisers using Canvas grew by over 1,800 to more than 2,900 in the year.

Our preferred partner program is also extending Canvas tax overlay capabilities to other asset managers, creating additional opportunities to scale the platform. Two years into our plan, Canvas AUM reached nearly $33 billion or about 2/3 of our original $50 billion fiscal 2029 target. Given this momentum, we are doubling our fiscal 2029 target to $100 billion in AUM.

Turning to Slide 22. Our ETF franchise continues to scale rapidly and is ahead of plan, driven by strong demand across fundamental active, systematic active and thematic country strategies. ETF AUM reached a record $84.6 billion with $27.5 billion in net inflows during fiscal 2026. For the first time in 2025, active ETF launches matched passive launches and industry forecasts expect active ETF AUM to more than double to approximately $4 trillion over the next 5 years.

As an active investment manager, Franklin Templeton is particularly well positioned to capture our share of this growth. Our active ETF AUM reached $37.2 billion and was more than half of our ETF net inflows. Investment performance is strong with 78% or more of active ETF AUM outperforming peer medians over the 1-, 3- and 5-year periods. Combined with our breadth of investment capabilities and global distribution, this provides a strong foundation to continue expanding our active ETF franchise. In year 2 of our plan, ETF AUM has reached more than 90% of our original $93 billion fiscal 2029 target.

Given this momentum, we are more than doubling our fiscal 2029 target to $200 billion. Beyond individual investment vehicles, clients are seeking integrated solutions that address broader portfolio needs, particularly across public and private capabilities. Our solutions business has grown at a 29% compound annual rate since fiscal 2023, reaching approximately $120 billion in AUM compared with projected industry growth of approximately 12% annually from 2026 to 2030, and we remain on track against our 5-year plan. We have a strong pipeline of opportunities, and our priorities include expanding OCIO, customized multi-asset portfolios and outcome-oriented strategies that bring together investment expertise from across Franklin Templeton.

Turning to Slide 23. Fiduciary Trust International, our private wealth management business remains an important long-term growth opportunity, supported by favorable demographic trends, including the estimated $84 trillion intergenerational wealth transfer through 2045. With a fully integrated platform spanning investment advisory, trust, estate, tax and custody services, Fiduciary Trust is well positioned to serve the increasingly complex needs of high-net-worth clients and families. AUM reached $45 billion, up 15% since fiscal 2024. The business serves more than 2,000 client relationships with an average tenure of 19 years and a 5-year asset retention rate of approximately 98%.

We remain focused on expanding this business through organic investments and targeted acquisitions. Having invested in blockchain technology for nearly a decade, innovation remains an important part of our long-term strategy. Digital assets AUM more than doubled during the fiscal 2026 to $3.6 billion, including approximately $2.5 billion in tokenized money market funds. Our Benji platform enables capabilities such as intraday yield calculations and more efficient asset transfers. With the acquisition of 250 Digital, we launched Franklin Crypto to expand our institutional digital asset capabilities.

We've also established partnerships across tokenized products, global distribution, collateral and liquidity solutions to create new ways for clients to access and use our investment capabilities.

In artificial intelligence, we are expanding adoption across sales, marketing, operations and investment management to improve productivity, strengthen decision-making and enhance the client experience. Beyond efficiency, we see significant potential to transform investment research and deliver more personalized solutions and insights at scale.

We are building the technology and operating model to capture that opportunity responsibly with disciplined investment oversight, risk management and human judgment at the center. Our focus on productivity and expense discipline will allow us to fund strategic investments in AI, our investment management platform and distribution while supporting further margin expansion.

As we close fiscal 2026, I'm pleased with the progress we've made in executing our 5-year strategic plan. We returned to broad-based organic growth, strengthened our investment capabilities and improved the efficiency and profitability of our business. As asset owners increasingly look to work with fewer, more strategic partners, Franklin Templeton is well positioned to meet their evolving needs. Our leadership across public and private markets, combined with our global reach and ability to deliver integrated investment solutions allows us to [ deepen ] client relationships and capture new opportunities for growth.

With several key growth areas ahead of plan, we're confident in our ability to build on this momentum. I also want to thank our employees around the world. Their expertise, collaboration and commitment to our clients has been essential to our progress.

With that, I'll turn the call over to Matt Nicholls to review our financial results and guidance. Matt?

Thank you, Jenny. I'll briefly review our fiscal fourth quarter and full year 2026 results on Pages 6 and 7 of the investor presentation, then I'll walk through guidance for the first quarter of fiscal 2027. I'll then provide remarks on our full year 2027 expenses and updated 5-year plan targets.

Starting with the fourth quarter on Page 6. Ending AUM reached $1.8 trillion, essentially flat from the prior quarter, while average AUM increased to $1.8 trillion, a 3% increase from the prior quarter. Adjusted operating revenues increased 3.7% to $1.88 billion from the prior quarter due to higher average AUM, an additional calendar day and performance fees of $94 million compared with $74 million last quarter. This quarter's adjusted effective fee rate, which excludes performance fees, was 37.5 basis points compared to 37.9 basis points in the prior quarter and flat or 37.5 basis points in the prior year quarter.

Adjusted operating expenses were $1.29 billion, a decrease of 1.7% from the prior quarter, primarily due to lower variable compensation and benefits and other expenses, including seasonal benefits, lower professional fees and realization of cost savings, partially offset by spend on strategic investments. As a result, adjusted operating income increased 17.6% from the prior quarter to $598.6 million, and adjusted operating margin expanded 380 basis points to 31.8%.

Compared with the prior year quarter, adjusted operating income increased 26.7%, reflecting higher revenues and cost savings, partially offset by strategic investments and expenses related to higher sales and fundraising. Our adjusted operating margin increased 580 basis points from the prior year quarter.

Fourth quarter adjusted net income and adjusted diluted earnings per share increased 27.7% and 30.6% from the prior quarter to $493 million and $0.94, respectively, primarily due to higher adjusted operating income, a lower tax rate and a lower share count.

Turning to fiscal year 2026 on Page 7. Ending and average AUM each increased by 8% to $1.8 trillion and $1.74 trillion, respectively, compared with the prior year. Adjusted operating revenues increased 7.5% to $7.2 billion, primarily due to higher average AUM from market appreciation and net inflows. The adjusted effective fee rate, which excludes performance fees, was 37.6 basis points compared to 37.5 basis points in the prior year. Growth in lower fee investment capabilities, including ETFs, Canvas and multi-asset solutions was offset by lower fee Western outflows and increasing flows into higher fee alternative assets.

Our adjusted operating expenses were $5.18 billion, an increase of 2.4% from the prior year, primarily due to higher sales and fundraising as well as higher formulaic incentive compensation driven by higher AUM, revenues and investment performance, partially offset by cost savings.

On to Page 17 of the investor deck. Excluding performance fee compensation, adjusted operating expenses increased 2.9% from the prior year, reflecting continued expense discipline while investing for growth in our strategic initiatives. Our fiscal 2026 expenses included $210 million of cost savings. Fiscal 2026 demonstrated the operating leverage in our model. Adjusted operating revenues grew 7.5%, while adjusted operating expenses grew 2.4%. So revenue grew at roughly 3x the rate of expenses.

As a result, adjusted operating income increased 23% to $2.02 billion and adjusted operating margin expanded 350 basis points to 28%, inclusive of our support of Western Asset. Compared to the prior year, fiscal adjusted net income increased by 37.4% to $1.64 billion and adjusted diluted earnings per share rose 38.3% to $3.07. The increases were due to higher adjusted operating income, higher adjusted other income, a lower tax rate and lower share count. On other topics, we continue to focus on capital management and operational integration to drive efficiency and long-term value.

As stated on Slide 18 in the investor presentation, from a capital management perspective, we returned approximately $1.2 billion to shareholders in fiscal year 2026 through share repurchases and dividends, which have increased every year since 1981. This year, as mentioned by Jenny, we also closed our acquisition of Apera. And in October, we announced our acquisitions of Stoneshield, further globalizing our real estate capabilities and Encina Lender Finance to expand our asset-backed financing capabilities.

Aside from maintaining the trajectory of our dividend, as always, our plan is to repurchase at least the shares that we issue for employee compensation. We will also opportunistically repurchase shares from time to time as we consider the balance of other priorities to grow the business.

In terms of M&A, acquisitions have already transformed our company over the past several years and achieved important strategic objectives. We will continue to consider acquisitions in areas where we cannot grow fast enough organically to be relevant in capabilities that are important to our clients.

Our balance sheet provides flexibility to invest in the business organically and inorganically. To support future growth and develop and scale new investment strategies, we have seed capital and strategic investments of $3.4 billion as of fiscal 2026 year-end, an increase from $2.8 billion from the prior year-end. Our debt-to-EBITDA is approximately 1.3x, and our balance sheet cash and investments covers our long-term senior debt by more than 2x.

Turning to fiscal year 2027 first quarter guidance. As a reminder, guidance assumes flat markets and is based on our best estimates as of today. For the fiscal first quarter 2027, we anticipate the EFR to be stable from this quarter in the mid-37 basis points as growth in lower fee key growth areas are partially offset by higher fee alternative fundraising. Importantly, our areas of growth in lower fee EFR are now adding to our corporate operating margin. We expect compensation and benefits to be approximately $975 million. This includes approximately $50 million of annual accelerated deferred compensation awards and assumes $125 million in performance fees at a 55% payout.

For IS&T, which includes investments in AI, data and security, we're guiding to $165 million, consistent with the prior quarter. We also expect occupancy to be flat to the prior quarter at approximately $70 million, and G&A expense is also expected to be flat at approximately $185 million. In terms of our tax rate, we expect fiscal 2027 to be in the range of 24% to 26%, with the first fiscal quarter at the lower end of the range due to favorable discrete items.

Referring to Page 17 of the investor presentation, while we're only 1 month into fiscal 2027, all else being equal, at the current level of AUM, which is 4% higher than the average AUM of fiscal year 2026, we expect adjusted operating expenses, excluding performance fee compensation, to be in line or slightly above fiscal 2026 levels at approximately $5.1 billion. We anticipate reaching an adjusted operating margin of approximately 30% in fiscal 2027. This would achieve our original 5-year margin goal 2 years ahead of plan.

Moving on from guidance to goals. As outlined on Page 24, our multiyear investments have resulted in higher growth rates versus our original 5-year plan as set in October 2024. As such, as outlined by Jenny, we are raising our fiscal year-end 2029 targets for private markets fundraising to $150 billion, ETFs to $200 billion and Canvas to $100 billion, and we expect further margin expansion from these areas.

We also see opportunities to improve efficiency and effectiveness in terms of both revenue and expenses by further simplifying the business. The unification of our public markets investment operations remains on track from a timing and funding perspective. And these efforts, amongst others, will help fund reinvestment in the business while improving profitability. Together, the scaling of our growth business and continued operational efficiencies support increasing our adjusted operating margin goal to 35% for the fourth fiscal quarter of 2029.

And now we would like to open the call for questions. Operator?

Our first question comes from the line of Brennan Hawken with BMO Capital Markets.

Thanks for the update. Really, really encouraging to see all the targets moved higher, particularly on the increased pretax margin for the exit rate for fiscal year 2029 up 500 basis points. So suggests you're adding 150 to 200 bps a year ex markets. Is that a fair way to think about it? And obviously, your private market revenue CAGR will favorably shift your revenue mix. How big a driver is that versus efficiency efforts?

So a couple of things. I mean, and I'll let Matt add on. If you look at 2026, our base fee growth rate was about 3%. We expect that to continue. And frankly, that we've got a lot of initiatives going on. For example, this kind of initiative around One Franklin Templeton, which is to bring in a more solutions and consolidated approach to institutional business.

Today, less than 10% of our institutional clients have more than one investment team serving them. So huge opportunity there. So we think those things can be the upside of -- on the revenue side. But we expect the continuation of the -- and remember, we don't include market in our margin. So we expect that 3% base fee growth rate to continue.

As far as on the expense side, we've done 18 acquisitions in the last 6 years, and it takes years. That's true. We don't talk enough about it, but it takes years to really do the integration of the back office. The obvious one that's the most public is Aladdin, but there's a ton around like CRM, integration of office systems, consolidating vendor contracts. And so all of that has been ongoing, and that will continue to go, and that will continue to improve our margin and enable us to have good expense control.

And then we have a bunch of AI initiatives where really from an expense standpoint, there, you should think about those as more in the operating side as opposed to just expense savings and things like the investment side. It's all about improving investment and performance. So I think that this is a path we've been on. We see it accelerating. We see some of the -- on the revenue side, some of the initiatives that we've had on really coordinating across our distribution, too, we think will pay dividends. I don't know, Matt, do you want to add anything to that?

No, I think Jenny covered it. And I think, Brennan, the way you described the sort of path to the 35% that we've outlined in the presentation to be the right way of looking at it. I'll just add, I mentioned this in my prepared remarks, but the other thing we're seeing is as the areas of investment that we've talked about, Canvas, multi-asset solutions, ETFs, private markets, as each of those areas gain scale, in particular, the lower fee areas, for example, even the lower fee areas, every dollar we're adding now is adding to the corporate margin. So margin uplift is occurring as a consequence of all of those things, even the lower effective fee rate.

Our next question comes from the line of Alex Blostein with Goldman Sachs.

So as you guys think through the 2029 plan and you budget where you're growing, so there's a lot of emphasis on the alts. There's a lot of emphasis on Canvas, SMAs and ETFs. These are obviously kind of pulling your fee rate in 2 different directions. But curious how stable you think the fee rate could ultimately be? Obviously, you articulated the margin story really well, but curious whether that can still be achieved with relatively stable fee rates amid this kind of barbelling or how we should think about, I guess, the fee rate broadly over the next couple of years?

Yes. I mean you definitely you hit it exactly right, which is obviously alts are on the higher end and Canvas and ETFs are lower, although active ETFs are a bit higher than some of the big areas of flows. And as long as we maintain -- I think with everything that's happened in the last couple of days, we should not forget that this is great for active management. Volatility is great for active management.

And our big equity sales, it's demonstrated with the success of Putnam Large Cap Value and their U.S. research and even the growth, but is that if you outperform on the equity side, you're going to get flows despite the headwinds there. And so some of it will depend on assuming that we continue to maintain that, and we think it's a good sign for active management. I would also say that we think there is opportunity on the fixed income side that probably a bit of the headwind on Western may be carried over a little bit even on the Franklin Templeton fixed income because we have outstanding performance across the board on our fixed income team. And we expect to see that increase as far as part of our distribution.

I'd just say 2 other things to that. Number one is if you look at the fundraising, as Jenny mentioned, possibilities that we have across both Lexington, remember, we've got another at least half of the Fund XI coming up in fiscal '27. And then other funds after that, plus Stoneshield, Clarion, Benefit Street funds, there's actually a lot of growth engines within that group that have the higher fee rate end of our business.

So as Jenny mentioned, that's certainly a very important offset. If you exclude catch-up fees, for example, from both '26 and '25, the effective fee rate was 37.4 basis points in both years, so very stable. And when we look forward to 2027, it's almost the exact same story, as I mentioned in my prepared remarks, we expect it to be 37.5, 37.6 something like that.

And then when we look a little bit more bravely forward to that, we don't really see anything that changes too much around that just because of the strength of the private market raise combined with a relatively stable mutual fund business at the fee rates you're familiar with there, plus the higher growth effective fee rates of the very high-growth areas that we talked about like Canvas, ETFs and multi-asset solutions and so on. So that's how we look at it. So yes, we do look at it as an effective fee rate that should, all else remaining equal, remain stable over the next several years.

One thing I will add, Alex, is that alternatives, within alternatives in wealth, which is also higher fee. This year, we've had about 22% of private fundraising coming from the wealth channel. But importantly, 34% of that is coming from non-U.S. parts of the world, which really adds to a lot of that. We added 62 new distribution outlets in fiscal year '26 only for alternatives in wealth and more than half came from EMEA, APAC, Latin America. So clearly, that's going to be another big area of growth that will help us balance the EFR.

Our next question comes from the line of Bill Katz with TD Cowen.

Okay. Great. Just a clarification, then I'll ask my question. On your '29 margin target, your footnote says flat markets. What is your assumption for performance fees? And if we were to assume markets were to rise, should we assume the same kind of 3:1 leverage ratio between revenues and expenses? And then the broader question I have for you, as you think about the business model over the next 4, 5 years to sort of align further to where you sort of see the growth of the business, it seems like organic growth is the focal point here, but how should we be thinking about how your capital management strategy may be evolving? And if you were to look at something, it still sound like more targeted deals from your prepared commentary, but how would M&A fit in there as well?

So in the margin question, could you just read that one more time? I want to make sure I fully understood your question, Bill, the first part?

Sure. Your 35% margin assumes flat markets, it looks like from your disclosure. So I was just wondering, what are you assuming for performance fees? And then if markets were to rise, if -- I appreciate day-to-day here, we don't know. But if things were to rise, you mentioned in your comment that your revenues are running about 3x the pace of expenses. Could we assume a similar 60%, 70% incremental margin on market action as we look out over the next several years?

Yes, I think that's fair. I also think on the performance fees, we estimate -- we discounted it by about 25% or 30% based on the last couple of years of performance fees that we've achieved. So something around the high 200s, 300, something like that for the year. But even if we didn't have those, that obviously helps our margin a little bit, but there wouldn't be a dramatic difference if we had lower performance fees based on how we're modeling the rest of the business. So I would describe that.

In terms of M&A, as I mentioned in prepared remarks, we're very focused on any area where we may have a gap. We don't have that many gaps now relative to where we were several years ago. So the bar is high in terms of where our current valuation is and buying back shares relative to M&A. But on the other side of that, M&A has been a big transformational moment for this company over the last several years, and it's worked for us for the most part.

So if there's an area where we think we can't grow fast enough organically and our clients demand it from us, we're going to be very focused on other ways of getting there faster. And M&A is one of those things that we've managed to make work. International is a very interesting example. We're a lot small -- even though we're sizable internationally with $540 billion or whatever is overseas. We're a lot bigger in the United States, and we see lots of opportunities to grow internationally in major markets where there's interesting trends that require professional asset management. So we're -- there are a few of the areas and then some bolt-ons in.

Well, I would summarize it that if you say what are the priorities, it would be the bolt-ons. The only gap we really have is infrastructure. We have it on the public infrastructure. We have small private infrastructure. But from a scaled infrastructure, that's the only really big gap.

And then as Matt said, if you look at what we did with Encina and Stoneshield, they're bolt-ons of capabilities to the big category. So if you're looking in fixed income, when you took -- when you talk -- sorry, private credit, you talk about fixed income, you would say, "Oh, I have high yield. I have investment grade. I have munis, I have asset-backed." But people talk about private credit, like it's one big category. But the reality is it has as many categories as traditional fixed income.

And so those types of capabilities, and fortunately, Benefit Street Partners is very broad in its fixed income capabilities, but we do look at bolt-ons like Encina, which gave us that asset-backed and then in Stoneshield. So it's bolt-ons to those types of things, particularly in private credit. High-net-worth, if we find these types of Penn Trust or Athena deals, we are always interested in those, although there's a lot of private equity money there. And then as that's really kind of local asset management, right? 80% of flows in markets tend to go to local products. We're the one big multinational that plays a lot in local markets. And so that's an area that can be interesting for us.

And to be clear on Stoneshield, it was a really, really interesting opportunity for us because on the face of that, it looks like it is just globalizing real estate, but it's actually a very interesting entree into more real assets and infrastructure in Europe. So it includes digital infrastructure, industrial storage, innovation. There's a few very key areas that we have no presence in today that Stoneshield is going to give us.

And I think it's increased Clarion's exposure in Europe by 3x. So...

Exactly, yes. So we're now 13% or 14% or something in Europe.

Our next question comes from the line of Dan Fannon with Jefferies.

So I wanted to follow-up on your outlook for the alternatives growth. I mean you've obviously had very strong growth recently, but can you maybe unpack what you expect to be the biggest contributors to growth going forward? And also just clarify in those targets does not include any inorganic contribution that may come going forward?

Yes, that's great. So a couple of things. So this year, the $43.2 billion is across real estate, secondaries, private credit, venture and even some of the Franklin Templeton had done some CLOs and infrastructure themselves on the fixed income side. So everybody has contributed. Of that, about $11 billion is Lexington's flagship fund, which is flagship XI. That is right on track from where they would expect to be. It's a little over half, and they expect that fund to be about the size of Fund X. And so they'll be continuing to fundraise into 2028.

The [ 37 ] -- we expect year '27 to be -- 2027 to be about mid-30s. And the fluctuation there of going higher is really around what the CLO market looks like. This year, the CLO market had quite a few re-ups and resets that are sort of unique at times. It was a really good year for CLOs. There was a lot of demand. So it will just depend about whether the market will have demand there, and that may swing a bit higher.

And then -- so we expect '27 to be around mid-30s. We expect that because obviously, if you do the math, you'll see '28 and '29 are a bit lower, and that's really because you're not -- we're not assuming that we're in the market with any particular flagship fund like Lexington. Now if real estate turns around and there becomes a great demand, there could be something interesting there. I will point out that the $100 billion we have in private credit, 95% of it is floating rate.

So for institutions that are -- that want exposure to fixed income are worried about rising rates, private credit with what Benefit Street Partners. And again, they're focused on middle market. So they're not funding the hyperscalers. They're focused on middle market, that's a great place to be. So those are kind of the swings. So the answer is no organic -- no inorganic. It's all organic in those numbers.

Yes. If we ever have anything inorganic, we'll just update the presentation.

Our next question comes from the line of Craig Siegenthaler with Bank of America.

So I hope you're doing well. Congrats on raising the fundraising targets. I had a question on the momentum at Canvas. I was curious, which products have been the biggest drivers recently between direct indexing, long/short tax aware, tax overlays. And I know you launched that new preferred partner program, too. And then also, in the last week, a member of the U.S. Senate Finance Committee actually wrote a letter to the U.S. Treasury, urging them to take a look at long-short tax-aware products. I'm wondering how you think about the risk of tax law changes to Canvas, especially in light of the Blue Sweep this week.

So I'm going to have Daniel answer on this. I would just say that we've avoided strategies that the Treasury is scrutinizing the 351 exchanges, the box spread, the ETFs that the dividends are avoiding. And so we don't see that as an issue. But actually, the Blue Sweep to the extent that taxes go up, there's going to be continuing more demand for tax loss harvesting and the efficiency at Canvas, but I'll let Daniel talk about the strategies.

So I'll say 2 things. One is our Canvas solution is very differentiated in the marketplace for 2 reasons. One, we are among the few ones that can do much more frequent tax loss harvesting rebalancing. So most of the competitors actually do once a month or once a quarter. We do it intraday. So that leads to better performance. And that's a big differentiating factor of Canvas.

The other one that is very differentiating is we are creating Canvas as a platform for advisers. So we combine Canvas. So that goes to your question, it has direct indexing. It also have income through options adjusted, our capabilities that we can give more income through options adjusted. We also have municipal bonds in the platform. So we can offer also municipal bonds in the platform.

We also offer as you referred to the P3 model, which is basically third-party fundamental equity tax optimization as well as our own fundamental managed tax optimization within the same platform. So that's a very differentiating feature. We have started to do a long/short as well. So long/short for us is really still very, I will say, very early stage. So the majority has been direct indexing as well as third-party and our own fundamental equities tax optimization.

We expect that to continue to be a big driving force as well as, of course, our strength on distribution that we have, which we added this year alone 118 new partners and RIA teams -- so now the total number of teams is 336. So the momentum is very high because as we build all these new teams, each of them have a lot of more tax loss harvesting that they want. And that's actually what gives us a lot of conviction that the platform will continue to grow Canvas.

Our next question comes from the line of Alex Bond with KBW.

Just quickly, I wanted to ask around the magnitude of catch-up fees in the quarter and also the margin guide for fiscal '27 incorporates any assumptions around further catch-up fees? And then also on the expense side, I think you mentioned $210 million of cost saves in the trailing year. Can you just speak to the scale of the expected savings in fiscal '27 relative to that $210 million? Just trying to think about how the savings and the ultimate level of reinvestments in the business might compare on a year-over-year basis.

Yes. So the catch-up fees for the quarter were $18 million, approximately $18 million. For the year, it's $44 million. So on the EFR, the $18 million represents something like $0.3 million, something like that. But as I said, if you look at it over the year, if you take into account retro fees, take those out, PFR year-over-year was 37.4 in both years, and we expect that to be similar in 2027, as I've explained.

In terms of the savings, 2027, right now, we're estimating that to be around $75 million, something like that. But it's a little bit of a target that goes up and down depending on the metric. Jenny always says, what's the net amount? What's the net amount? It's not just about the gross savings. But right now, we've earmarked around that level.

And the reinvestment is at least that significant, I would say. So yes, we're very optimistic of areas as we talked about at the beginning, where we can lever that saving amount where we need to in order to reinvest more and save more as needed. So we are confident in our target that we gave you for the year.

Our next question comes from the line of Michael Cyprys with Morgan Stanley.

I wanted to ask about private markets in the wealth channel. You've seen success with your platform of evergreen strategies, nearly $10 billion. I was hoping you could speak to the steps that you're taking to accelerate growth from there into fiscal '27, where you're most optimistic on seeing meaningful growth from here? Maybe speak to some of the opportunities around models. And just more broadly, how are you thinking about evolving cost of distribution into the wealth channel for private market strategies?

Yes. So I mean, I think Daniel covered some of this in there. But today, I think we've added 62 -- in 2026, we added 62 distributors to being able to distribute our wealth products and a lot of interest in Asia. That has probably been a big surprise for us is how much interest in Asia. And we have -- I just came back from Hong Kong, where in 2027, we will celebrate 40 years in Hong Kong. I was in the UAE. We're celebrating 30 years in the UAE.

These are markets that the retail wealth channel knows our brand really, really well. And so we have built out a huge force already in our expense numbers with 100 people who are just there supporting distribution with expertise on the wealth channel. In the wealth channel, sales is hand-to-hand combat. It's each adviser. It's not only getting on the platform, it's each adviser.

So we've already experienced a lot of that expense. Now it's about getting on those platforms. And as I mentioned, we've added 62 of them, and we have great vehicles to be sold there. We have at least 6-plus evergreen products, of which I think 3 are over $1 billion. I don't know, Daniel, what else you want to add?

I'll add that innovation is a big driver on this space, Michael. We have new evergreens also coming in infrastructure, multi-asset evergreens. So that's clearly an area that is growing. The other one is we just had the closing of our first CFO collateralized fund obligation this past quarter, $1.5 billion that actually covered retail, VA and insurance companies.

And also, as you mentioned, the partnership with Corastone on model portfolios, we are in advanced conversations to try to have it up and running and having this in model portfolios. And finally, I will say also on the target date, we added privates into our target dates between 3% and 8% across different evergreens, and that's already having like early results in terms of momentum.

So I think on the product side, a lot of momentum. I did mention also the success of 34% fundraising coming from outside the U.S. And I will also double down. Europe was also good and Latin America had like great success for us. And a lot of this is just newly appointed or new distribution outlets that will start to pay off in '27.

Our next question comes from the line of Brian Bedell with Deutsche Bank.

Maybe just in context of the 5-year plan, but also more just futuristic thinking, you guys have been so forward thinking on tokenization and digital assets. Jenny, how does the sort of long term or your long-term view on tokenization in asset classes outside of money market funds? How does that influence or I guess, what part of the 5-year growth plan would be considered attributable to that? Or would that be upside to the plan?

And then just also your house views on equity tokenization with the SEC innovation exemption how the fundamental teams are thinking about that? And if I could throw one more product in there, and that would be a company KPI event contracts. That's obviously a new emerging asset class that has good potential within institutional investment. Maybe any early thoughts on if you would adopt those in the fundamental strategy?

Yes. So here's what I'd say, Brian. Why is tokenization? Why are we bullish on it? It is a really good programming language that does create huge efficiencies in our business and will enable innovation. And so again -- and I've talked about this before, when we did the -- when the SEC approved our tokenized money market fund, we had to parallel process our old recordkeeping transfer agency system with the blockchain system, and we were astonished by the difference in cost savings.

And so that's why we're really bullish that the rails of financial services will ultimately be on chain. We actually -- we don't differentiate it out in our 5-year plan as far as tokenization as a category. So for example, today, we have tokenized ETFs on the crypto exchanges. If you just take the top 5 crypto exchanges, they have 1 billion wallets. It's slow adoption there. Most people are there, they're buying crypto products, but we are getting some adoption there.

As other mainstream players add wallets, then these types of products can go. I think it depends on how important the 24/7 trading is. I do think we'll get to a world where that will be more and more important. Both of the exchanges are struggling because you have this reality of 2 different rails, the old rails, which are based on batch systems, people have to upload and reconciliation and the new rails.

And then can you -- let me just ask clarity on the KPI company. Are you talking prediction markets? Is that where you're going? And if yes, then let me just say, look, we actually think the prediction markets information is interesting. And we have a partnership with Kalshi. We talked to Kalshi and get some of that data.

We're not investors in the prediction markets, meaning we don't invest in whatever the bet is on that particular thing. But we leverage that data, particularly into our systematic models just because it gives you a view of what the kind of individual consumer is thinking. And so tokenization probably will be -- again, the technology is such with the smart contracts that it can be a really efficient way to use it, but they -- it will evolve over time. So long answer to that, we don't have any particular numbers broken out in the 5-year plan on digital assets.

Our next question comes from the line of Patrick Davitt with Autonomous Research.

There continues to be a lot of announced revenue sharing changes at the largest wealth platforms. Could you update us on to what extent you expect those changes to impact you? Why or why not? Secondly, remind us how you report those revenue sharing expenses? Is it net of fee rate or in the expenses? And finally, to what extent are those changes baked into your fee rate and/or expense growth guidance?

Yes. I mean, look, rev share is the nature of our business. It's something we've negotiated and navigated for 50 years. So we will continue to do so, and it's no surprise that as the world has been shifting from mutual funds to ETFs, since the platforms are interested in having some sort of revenue share because they do a certain amount of servicing of those clients. Matt, on the -- what I would say is we've been in these discussions for several years now. So there's nothing -- I mean, maybe it's something that's become more aware with you guys, but it's baked into our numbers. So the way we are today is how you would see it.

Our next question comes from the line of Ben Budish with Barclays.

I wanted to just ask about the performance fee expectation for next quarter. I think typically, you guide -- when you talk about your cost to $50 million per quarter sort of as a baseline, it sounds like you're expecting that to be a little bit better. Anything kind of different going on crystallization from any of your alt products? Is there anything else we should read too for the rest of fiscal '27? Or is that commentary really just specific to the next quarter?

I'd just say there's more activity around our venture capital group that's invested in some of the...

You may have noted some high profile...

Some prominent investment that everyone is aware of. So we're invested in a number of those companies. So yes, you'll see some higher performance fees in the next several quarters, and we'll obviously call those out as we get our guidance.

Our next question comes from the line of Mike Brown with UBS.

You guys have talked a little bit about the alternatives platform here. And the fundraising backdrop for the industry still remains a bit tight, but clearly, you've been outpacing your growth. So your products are really resonating in the market here. But you did raise your target by 50%. And so I just wanted to maybe hear a little bit more about some of the building blocks beyond 2027 that kind of support the confidence to raise that target here? And maybe just give a little bit of color on what you're seeing in that pipeline and some of the underlying demand there.

Yes. So I mean, again, we probably have the broadest breadth of capability in the private markets of any asset manager out there. And so when you just look at the fundraising that we've done so far, not only I already mentioned, it's real estate, it's secondaries, it's private credit, it's venture. But probably more interesting is it's 30 different strategies, right? So this is a very diverse capability that has distribution coming globally. And so that's what's given us more confidence the stuff is resonating.

Secondaries, I do think that probably rising rates are going to have an impact on the private equity market. But actually, secondaries can go in and buy based on today's rates. And so a lot of people who want exposure to private equity are actually preferring secondaries. You get -- you have no J curve, you get a much more diverse portfolio. It's getting repriced right now essentially as no buying books. And so that's been a really strong area in what has been a little bit more anemic fundraising on the private equity side.

As I mentioned on private credit, 95% is floating rate. If you're worried about where rates are, it's a great place to be. And the economy still remains very strong. And so if you've got a fixed income allocation and you can withstand the illiquidity, you're getting a premium in the private credit market and you're getting protection against rising rates. The one area -- and Ventures venture, we've seen that there's -- and so much time is spent on the AI infrastructure and not enough time is spent on all the other incredible innovation that is happening between material science, biologics, new drug pipelines, 3D printing, there's a ton of technology out there that makes the venture really, really interesting.

And so again, as an active manager looking in that space, you may say these things are overpriced. I like some of this other stuff. And so we think venture will continue to have good demand. And then real estate, it kind of depends on where you are. You can see it being slower if you're doing development because people worry about the higher rates. But if you are a landlord, which Clarion is in places, rates often rise with inflation. So it could be a really good income source as well as inflation hedge. So that's what's given us confidence that we'll hit those new numbers.

I will add that the One Franklin Templeton approach to selling, especially institutionally, is also giving us much more white space. Jenny mentioned the 10% of institutions just having one capability from Franklin. So clearly, there's a lot of opportunity. The teams are coming together. So they're offering that across the organization.

And results are starting to show like our fundraising like quarter-over-quarter went doubled actually over the past 2 quarters on the institutional space across -- in this case, across all products. But there's a lot of opportunity on the private side to continue to do that. And we've added also resources in Asia Pacific with other resources in Asia Pacific, with other resources in insurance and in other segments that we were not covering before as proactively. So clearly, that will add more to the confidence on the fundraising that we put in front of you.

And we have reached the end -- concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's CEO, for final comments.

Well, thank you, everybody, for joining the call today. And once again, I want to thank our employees around the world for their continued dedication and service to our clients, and we look forward to speaking to you next quarter. Thank you.

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

Welcome to Franklin Resources Earnings Conference Call for the quarter ending June 30, 2026. Hello. My name is Maria, and I'll be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions]

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

Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements.

These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings.

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

Thank you, Selene. Welcome, everyone, and thank you for joining us today to review Franklin Tepleton's third fiscal quarter results. I'm joined today by Matt Nicholls, our Co-President and CFO; and Daniel Gamba, our Co-President and Chief Commercial Officer. We'll answer your questions momentarily. But first, I'd like to highlight key results and themes shaping our business.

This was another strong quarter for Franklin Tepleton that demonstrated our strategy is working. We delivered another quarter of positive long-term net inflows with positive flows across every asset class in every geography. We also reached new highs in assets under management across many of our key growth businesses including alternatives, ETFs, retail SMAs, canvas and our institutional pipeline. Together, these results reflect the strength of our global platform and the momentum we're building across the business.

Today, we are ahead of our 5-year plan, a testament to disciplined execution. We have broadened our capabilities across public and private markets, deepen client relationships and expanded the ways clients access our investment expertise. These investments are creating multiple sources of organic growth and positioning us well for the future. At the center of our strategy is One Franklin Templeton. Increasingly, clients are turning to us not just as an asset manager, but as a trusted partner that combines investment expertise, innovation and global scale to help them navigate complex markets and achieve their long-term objectives. We continue to simplify our go-to-market approach to better serve clients and capture opportunities across the business.

The results we reported today reflect strong execution in the quarter with $18.4 billion in long-term net inflows bringing fiscal year-to-date long-term net inflows to $63.3 billion. This was another consecutive quarter of positive net flows with positive net flows across every asset class and geography. Long-term inflows reached a record $122 billion, and assets under management grew to a record $1.8 trillion. Each of our key growth areas, including alternatives, and private markets, ETFs, including fundamental active ETFs, retail SMAs and canvas, multi-asset solutions and our international franchise contributed meaningfully to the quarter. That broad-based performance reflects the investments we've made over the past several years to build a more diversified business.

The strength of our business today is translating into future opportunities. Our institutional pipeline of one but unfunded mandates reached a record $28.6 billion, increasing more than $8 billion from last quarter. Institutional clients continue to seek strategic partners that can deliver integrated solutions across public and private markets rather than individual products and that plays directly to the strengths of our platform.

One of the most encouraging developments this quarter was the continued strengthening of our public markets franchise with growth broadening across asset classes and investment capabilities. Equity returned to positive net flows of $2 billion, reflecting strong demand across U.S. large-cap value, U.S. large cap core, international equity, infrastructure and systematic strategies.

Our global fixed income platform generated $2.6 billion of net inflows supported by broad-based demand across enhanced liquidity, municipals, multisector, stable value as well as highly customized institutional mandates. Excluding Western Asset, Franklin Tepleton fixed income delivered its tenth consecutive quarter of positive net flows with $3.5 billion of net flows, while Western continued to stabilize.

We're also seeing clients think differently about credit. Whether then reviewing public and private markets separately, they're looking for integrated solutions. Franklin Templeton fixed income $520 billion platform, together with our private credit capabilities of more than $100 billion gives us more than $620 billion in AUM across the full credit spectrum. That breadth positions us well as clients increasingly seek fewer partners that can provide solutions across public and private credit.

We won a multi-asset credit mandate from a public plan and are participating in various RFPs. Multi-asset has consistently been an important contributor to growth and this quarter generated $4.7 billion of positive net flows led by Canvas, Franklin Income Fund and Franklin Templeton Investment Solutions. As mentioned earlier, these results reinforce that our public markets franchise is broadening the sources of our organic growth with clients increasingly relying on Franklin Templeton for active strategies, outcome-oriented solutions and customized portfolios.

Private markets remain one of the industry's most compelling long-term growth opportunities. And we believe Franklin Templeton is uniquely positioned as a leading partner in this space. We've built one of the industry's largest and most diversified private market platforms spanning secondary private equity, private credit, real estate and venture capital.

Alternative AUM reached a record $294 billion during the quarter after $3 billion of realizations and distributions. We raised $11.8 billion across our Alternatives platform during the quarter, including $10.3 billion in private markets, bringing fiscal year-to-date fundraising to $33 billion, already exceeding our original full year target with one quarter remaining. Fundraising remained diversified across strategies and client channels, reflecting the breadth of our platform and continued demand from both institutional and wealth clients.

As private markets become more accessible, we're also seeing continued growth in the wealth management channel. Our Evergreen platform across secondary private equity, private credit and real estate grew to $8.9 billion in AUM, reflecting increasing adoption by individual investors. Wealth Management accounts for approximately 20% of our private markets fundraising year-to-date across evergreen and drawdown vehicles, demonstrating the progress we're making in bringing institutional quality, private market capabilities to a broader range of investors.

We believe expanding access to private markets will be one of the industry's most significant long-term growth opportunities and Franklin Templeton's long-standing adviser relationships position us well to capitalize on that trend. More broadly, clients increasingly want choice, not only in what they invest in, but how they access investment capabilities because preferences vary across client segments, distribution channels and geographies. We offer a broad range of investment vehicles to meet those evolving needs. That strategy continues to gain momentum with a record AUM across our ETF retail SMA and canvas businesses.

Our ETF franchise reached a record $75.6 billion in AUM with $7.1 billion of net inflows during the quarter. ETF's have become an increasingly important way clients to access our investment capabilities, and we continue to expand our offering by bringing more of our highest conviction active strategies into the ETF wrapper. Active ETFs account for 61% of ETF net flows, reflecting both the strength of our investment platform and continued demand for differentiated active strategies.

Demand for personalized investing continue to grow. Our retail SMA business reached a record $187.6 billion AUM with $4.4 billion of net inflows, while Canvas, our custom portfolio solutions platform grew to a record $30.3 billion in AUM with $3.7 billion of net inflows. During the quarter, we also launched our preferred partner program, extending Canvas' tax overlay capabilities to strategic partners.

With clients in over 150 countries or about 80% of the world and on the ground presence in over 30 countries, our international business continues to be an important differentiator for Franklin Templeton. International AUM reached approximately $525 billion with positive long-term net flows in every region. Innovation also remains central to how we continue to evolve our business. We're investing in new capabilities, technologies and distribution channels that expand client access and strengthen our competitive position and digital assets are a good example.

Digital asset AUM ended the quarter at $3.2 billion, including $2.4 billion in tokenized funds and approximately $600 million in crypto ETF. During the quarter, we completed our acquisition of 250 digital and launched Franklin Crypto, expanding capabilities across the digital asset ecosystem. We also announced a partnership with MoonPay and we'll collaborate with Payward, the parent of Kraken to expand access to tokenized investment products and bring traditional financial assets on chain.

These initiatives reflect our belief that blockchain will become an increasingly important part of financial markets and Franklin Templeton attends to be at the forefront of the evolution.

Strong investment performance remains fundamental to earning our clients' trust and supporting long-term growth. More than half of our mutual fund and ETF AUM outperformed peers over the 3-, 5- and 10-year periods, while nearly half is rated 4 or 5 stars by Morningstar. Our strategy composites also delivered strong long-term results with 55% or more of AUM outperforming benchmarks over the 3- and 5-year periods and 70% over 10 years. Consistent performance across market cycles continues to strengthen our ability to win and retain clients.

Turning briefly to our financial results. Adjusted operating income increased to $508.9 million, up 7% from the prior quarter and 35% from a year ago. The improvement reflects higher average AUM, disciplined expense management and the continued execution of our efficiency initiatives, demonstrating the operating leverage of our diversified business model.

As we look ahead, we're confident in the direction of the business. The investments we made over the past several years have created a broader, more diversified Franklin Templeton, and we believe that positions us well to continue serving clients and delivering long-term growth. We remain disciplined in managing expenses while continuing to invest strategically in the capabilities while maintaining financial flexibility to drive long-term growth and return capital to shareholders. This quarter, we returned $521.5 million to shareholders, including $348.1 million in share repurchases.

In the spirit of One Franklin Templeton, as announced in our earnings press release, our parent company will officially change its corporate name from Franklin Resources, Inc. to Franklin Templeton, Inc. on August 17, 2026. This change reflects the continued evolution of our firm as a unified global organization and aligns our corporate name with the Franklin Templeton brand. This is a corporate name change only and will not affect the company's corporate or capital structure, domicile, outstanding shares, CUSIP number or the voting or other rights of its stockholders. The company's common stock will continue to be traded on the New York Stock Exchange under the ticker symbol BEN.

Aligning our legal corporate name with our global brand reinforces our commitment to 1 Franklin Templeton, 1 organization, 1 brand and 1 consistent experience for clients, investors, partners and employees around the world.

Finally, I'd like to thank our employees around the world. Their dedication and commitment to our clients are what make these results possible. Now I will open up the call for your questions. Operator?

[Operator Instructions] Our first question is from Bill Katz with TD Cowen.

Jenny, you laid out very strong growth at the beginning of the year for private markets and that you've already exceeded your year-to-date target with one quarter to go. Can you unpack where you're seeing the strength and where you might be in terms of Lexington Eleven and the outlook for that as well?

Sure. Thanks for the question, Bill. So at the beginning of the year, we had a target of $25 billion to $30 billion as far as the raise in private markets. As you kind of pointed out, we're now at $33 billion, and we expect to end the year at about $40 billion. Lexington's flagship fund by September, they're very much on track with their fundraising expectations. By September, they should exceed $10 billion. Of the -- what we've raised so far, so let me talk about this quarter.

So this quarter, we did $10.3 billion. Lexington is about 40% of that. However, that 40% is in 4 strategies. So their flagship fund, their middle market fund, their continuation vehicle and the perpetual all raised and contributed to that. In addition to that, the -- of the $10.3 billion, every single one of our private market managers contributed. So it's secondaries, it's real estate, it's private credit. All 3 of the kind of private credit managers that are under BSP contributed to that as well as venture. And actually, it's 30 different strategies that were all part of that $10.3 billion.

So what makes us really excited about it is that this isn't a one-off kind of just the Lexington flagship. This is really a diverse fund raise, and we're continuing to see momentum across the board. And one area that has kind of come back a bit this year is real estate, which was really out of favor, and we're starting to see some good traction there.

Our next question comes from Alex Blostein with Goldman Sachs.

I wanted to ask you guys around fixed income strategy broadly. You've made some changes kind of trying to bring the liquid and private pieces together given the convergence in this kind of part of the market, can you just talk through your new go-to-market approach? How are you thinking about the opportunity in fixed income broadly and how much they could accelerate growth for Franklin as a whole between liquid and private side of the house?

Yes. Thanks for that question, Alex. So I'll start and then I'll have Daniel add on to it a bit. Look, we think that any fixed Income Manager of the future is going to have to have visibility both on the public and private side. Like if you -- you don't have some way to sort of have insights into the private markets and your traditional fixed income manager, we think you're managing money with pretty big blinders on. So we're doing a lot.

We, as you know, have already integrated Brandywine and Putnam into the Franklin fixed income, great traction there. We've had 10 consecutive quarters of positive flows and have been working on bringing Western in. A lot of the work on Western was around kind of the back office and integration in areas like client service, institutional client service and on the institutional sales side.

On the investment side, Mike Pecan and the CIO of Western is now reporting to [ Sonal ]. So the key is not to confuse the independence of an investment team with the ability to have greater access to resources. So for example, the work we're doing in AI, it opens up a lot more data available to the analysts to be able to leverage -- to be able to pick up the phone and talk to a sector analyst in another area, we have the private markets team today. They talk -- they'll work together, they'll talk about macro, but I think as we look forward, we think it's going to be more and more important that they continue to get closer and closer.

So we're $620 billion fixed income manager of that $100 billion of it is private markets. But we really want to present to clients much more of a look of one big fixed income manager. And as you know, we hired an origination team. We think they're going to be important. Any fixed income manager of the future is going to have to be able to have some of their own sourcing. We think that's going to be an important part of the future of fixed income. And then obviously, the teams will be able to choose whether they want to opt in to certain deals or not.

But as we look at product development in the future, and maybe I'll ask Daniel to talk about this a little bit, it is clear that you're going to see more and more fixed income that incorporates both public and private. And we think a much better way to manage that is kind of under one umbrella versus just independent sleeps. Daniel, do you want to add anything to that?

Of course. Alex, thanks for the question. I'll have 3 quick things. Number one is the reaction to the Western settlement, if you want, has been positive from clients. And the client service teams have conducted outreach to the distribution partners and institutional clients. And the main questions were stability of the investment team, no changes to the investment philosophy. So it's been quite positive, and we're excited about the reengagement process that we're actually doing as we speak, which I think it has upside, especially on the institutional side, given the strength of Western clients and relationships over the years.

Two other points. One area of focus, as mentioned by Jenny is multi-asset credit, and that's been where we develop solutions by not only combining leaves, because I think a lot of what we've seen in the market is leaves. People want CPMs to actually work together to bring the capabilities across the spectrum of credit. And we just won a multi-asset credit mandate from a public pension in the U.S., but we are also actively in several conversations on RFPs and advanced conversations across multi-asset credit. So we're very excited about what's happening in multi-asset credit.

Last point, new products. We just launched our target date, we repositioned one of them, which is called Retirement Advantage to include private markets between 2% and 8%, private real estate and private credit and is having initial good looks from clients, and we're also in the process of launching an infrastructure product that also combines public and private -- private market partners, but also can clear bridge and some other areas that we are also doing to combine.

So this is an area that you're going to hear more from us because it's a key differentiator given that we have our capabilities insight and the investors are starting to gather insights among one another. So it's an area of future development, Alex.

Our next question comes from Dan Fannon with Jefferies.

So I wanted to expand on the $11.8 billion in fundraising. So how much of that is actually in fee paying AUM. And then also kind of like what's the average fee rate of the kind of assets you're raising across, I think you said 40 different strategies. So some great -- just kind of blended averages that fee rate would be helpful?

So the 30-plus strategies is a little over 30%. Across our private markets platform, about 80% is fee direct generating. So that kind of gives you the number and it varies a bit. I don't have the blended number. I don't know, Matt, I don't know what we provide there on the blended number. Do you have that?

The blended number is about 65 basis points, blended number. But it ranges between 40 basis points and over 100 basis points, plus performance base.

Our next question comes from Glenn Schorr with Evercore ISI.

On canvas, I'm interested if you look at the flows in the quarter relative to overall AUM, that's an enormous growth rate. You did have some white label wins. I'm curious if you can parse some of that out. But then more a big picture of what kind of growth you're expecting? Are there other white label opportunities in the pipeline? And then maybe sidebar of -- in terms of strategies that you deploy, how much of it touched on the area that seems to draw some treasury comments during the quarter? I appreciate it.

So since we acquired Canvas, they've gone from $2 billion to $30 billion. So just a tremendous growth rate. And we think this is just still early. If you think about what is Canvas. So many of these tax optimized platforms were developed by tax people, and so they have a fair bit of manual labor to them and that limits some of the flexibility. Canvas was developed by Claude managers, so they were very tech focused. And so there are some features in Canvas that other platforms can't do. So for example, the managed option strategy allows them to handle concentrated stock positions and help diversify the portfolios, tax efficiently. They can take in-kind transfers in. So those are pretty unique features about Canvas.

And the way we look at it is every time we sign up a new RIA, new wirehouse platform, any new platform that just opens up and widens the funnel of what's going to come in. Occasionally, you'll have a one-off that will be a switch in, but more importantly, it just opens up the funnel that people have selected that as their platform to leverage and you'll just continue to see flows. Now the future of campus and what gets us really exciting is being able to -- what started out as more of a direct indexing platform is really attacks overlay on active strategies. And so we think that as our SMA business -- so today, we're $187 billion in SMA, we're a large SMA provider. But what really gets exciting is when you can add the capabilities of Canvas' tax overlay on SMA platforms on the active strategies.

And in fact, our preferred partners program, we've been selected by some firms who manage active strategies. They selected Canvas to be the overlay on their strategy. So that's kind of a white labeled version. And again, it's because it's just -- it's a really excellent technology. Daniel, do you want to add anything to that?

I would only add that this quarter, we continue to onboard new partners, and that's a big driver of where we are. So we added 26 new partners, which is still increased and total number of partners that we have now is 220 partners. So that's a big driver of the growth. And I will also highlight the strength of the product is actually what's driving a lot of the success. We have more frequent rebalancings and also ability to receive in-kind holdings. And as you see the driving of people moving money from a commission base into fee-based, this is a big transition tool that some of our partners are setting to use. You saw it last quarter. Actually, I will say in Q2, and we have -- we're excited about the pipeline. The pipeline is looking strong.

Our next question comes from Patrick Davitt with Autonomous Research.

A couple of guidance cleanup. Sorry if I missed it in the rest, but could you give the scale of the catch-up fees in management fees. And then on the expense guide, just confirming that we should add some variable expense to that based on whatever revenue growth we are assuming for 4Q?

Yes. Patrick. First of all, so for the quarter that we're reporting here, the catch-up fees were $14 million, and we expect it to probably be about the same in the fourth quarter.

In terms of the guide, I'll quickly run through it. We expect the effective fee rate to be roughly the same as what it was this quarter that we're reporting today in the mid- to high [ 37 ], again, very similar to the quarter we're reporting today.

Compensation, we expect to be $850 million. This is at a $50 million performance fee level at a 55% payout. IS&T, we expect to be at $165 million. This includes investments in AI, data and security. Occupancy, we expect to be $70 million consistent with the previous quarters. G&A, we expect to be $200 million. The $200 million includes elevated fundraising and advertising that we also talked about last quarter. And we expect the tax rate to be between 25% and 27%, both for the fourth quarter and for the fiscal year as a whole.

In terms of the full guidance for 2026, of course, you can add the numbers I just went through to the 3 quarters that we reported already. But as outlined on Page 14 of the IR deck, this assumes flat markets from now and excludes performance fees. It's inclusive of our savings that we've also presented in previous quarters, we expect expenses to be about 3% to 3.5% above full year '25. This modest increase is driven by increased markets to date, higher sales, higher fundraising to date and strong performance. Inclusive of the performance fee guide, I just mentioned, total expenses would be about 2% to 2.5% higher versus 2025.

Importantly, though, as it relates to the margin taken in conjunction with revenue increase to date in revenue as expected for the rest of the year. We again have moved further ahead on our margin expansion. Targets, specifically we expect to reach very close to 30%, if not at 30% for our fiscal fourth quarter. And at least in the mid-27s, maybe a little bit better than the mid-27s, for the full year 2026, along with a declining compensation ratio in 2026. This, as you know, is ahead of plan, and we expect to reach at least 30% -- probably 30% plus margin later in 2027. And specifically in 2027, we would expect the full year margin to be between something like 29% and 30%.

In terms of the EFR for the full year, we expect it to remain stable at 37.7% to 37.8%, something like that in the high 37s.

[Operator Instructions] Our next question comes from Ben Budish with Barclays.

I was maybe going to follow on Patrick's question there. I think you kind of answered some of the questions around what spending might look like in fiscal '27. So maybe on the fundraising side, for the [indiscernible] which is probably the most control at least where you kind of have the most visibility into your plans, maybe give us a little bit of a sense for what you expect to have in the market. I don't know if it's too early to kind of give your full year fundraising expectations, but what does the product pipeline look like? And are there any implications for the EFR, I think the forward commentary was quite helpful, but it seems like if you keep fundraising at this level, I guess, depending on what happens with markets that could continue to be constructive for that as well. So any additional color there would be very helpful.

Yes. We'll give you really at the next quarter kind of the projections for '27 as far as the [indiscernible] fundraising. But the -- just kind of looking at the list of things that we're fundraising, I think we'll have most of the same things in the market next year that we have in the market right now. So we certainly hope to continue to keep the momentum. And I would say that this -- so far, we're at 20% in the wealth channel. And I think we have a real advantage in alternatives in the wealth channel because alternatives sold in the wealth channel, I described it as hand-to-hand combat. You not only have to get on the platform, but you have to educate adviser. And our coverage gives us an advantage there.

So we've always said that our goal is to be 20% to 30% of it in the wealth channel. We're at 20% now. And so we hope to continue to grow that as well. But we're going to -- we will provide '27 guidance at the end of next quarter. As I said, for this coming quarter, we expect to end the year at about $40 billion.

And same thing on expense guidance. I already mentioned a little bit from where we expect margin to be because we're very focused on margin and making sure that we get the margin uplift that we presented. So for '27, I just touched on that slightly, but we'll give more details, as Jenny mentioned in the next quarter as we talk about the fourth quarter or as we present the fourth quarter and then going into 2027.

In terms of the EFR though, as we run our analysis on our expectations, we do expect that to remain stable in the mid-37s.

I was going to just add some color on the alternatives in wealth because I think it's worthwhile this quarter, we had [ 3 billion ] fund raised in the wealth channel for the quarter across really evergreen and drawdown strategies, which fiscal year-to-date, $6.6 billion, which -- that's the 20% that Jenny was talking about, but also the other part that is worthwhile mentioning this international. We continue to have international growth, 29% of the sales are coming internationally; from Europe, Middle East, about 18% and APAC about 11%, driven by new markets, signing up to our Evergreen program as well as, in some cases, some institutional sales in Asia, especially, I will say, a lot of the institutional sales coming from Asia.

And we're also starting to broaden across different structures. So we have a great diversified platform that is helping with real estate debt is starting to have some good momentum, [indiscernible] having good momentum beyond, of course, Flex. And we're also -- going forward, we are driving some innovation in the space. So we announced a model portfolios with Cornerstone, which is also helping us to deliver SMA style model portfolios with a single ticker. And we're also looking at demand from clients on infrastructure and venture and growth. So those are also areas where we see the demand going forward, which is going to continue to strengthen our presence in wealth on alternatives.

Our next question comes from Michael Cyprys from Morgan Stanley.

So over the last year, you've rolled out a number of AI initiatives across investments, distribution, operations, including your partnership with Microsoft. So just hoping you could follow up on that. And as you look across your efforts today, where are you seeing some of the highest return on investment? Where is adoption or the impact maybe been a little slower than you initially thought? And as you look out over the next couple of years, which workflows or functions do you think could be most likely fundamentally redesigned that could have the most meaningful impact on your business from AI?

Yes. Thanks for the question, Michael. So I'm going to start with the intelligence hub in -- which was the partnership we did with Microsoft because it was very early on and we've now, after a couple of years, are actually starting to get real metrics around it. So again, this was a simple problem, how do you ensure that your salespeople are seeing the right clients and having the right conversations being as efficient as they can. And -- but it's actually quite a complicated technical solution because it requires you to have agents that talk to each other, and that's why Microsoft was excited about it.

So we've rolled it out. We have seen that in the territories, which it's pretty broadly rolled out now, a 25% increase in the number of clients that they're able to visit or contact and about a little over 11% uplift in sales, and we would expect that to continue. So that's a fairly mature AI project, which as -- we think that the sales lift will continue to increase.

In the investment side, our approach has been very much like let's let our teams build -- we've got over 1,000 agents working on different investment teams. We have multiple partners, not only Microsoft and Amazon, but like and [indiscernible] they approach it in different things. And we've been really trying to encourage our investment people to just go out and build agents get comfortable with it. Over time, I think what will happen is you'll start to look at it because every time you build an agent and it runs, it costs you money. So you'll start to look at it and say, well, okay, how effective are these things? But today, it's all about efficiencies in the research analysts models. So therefore, they get more time and hopefully gain more insights.

We have a couple of our PMs and research folks who are particularly focus on the AI. We built -- we funded 3 strategies, and I'll describe it at a very high level, which is essentially to say, one of the strategies uses AI for the research function. The second strategy, think of it as using AI for the portfolio construction function, and you're trying to get learnings from those.

And then the third is a kind of full on AI investment strategy. Our goal -- we don't care whether these are ever commercial or not. Our goal is what will we learn in the process there. So we think of that as like an R&D sandbox kind of from our investment teams. And then with respect to operations and technology, we track how much code is written by AI. So that's one measurement that can be good or bad. And then within our operations group, we have multiple different ways in which we're -- whether it's RFP processing, where we're trying to create efficiencies in our marketing group, you're doing due diligence and RFPs there that you're trying to make more efficient. So we kind of put that bucket in cost savings.

We're still building those out, and we have multiple -- every department has -- we have a measurement of, okay, what are the initiatives that you're doing? And what are you putting as a target for cost savings or increased productivity, volume increase across the company, and we're tracking those.

I'd say we have, Michael, we have a lot of key tables. On the left side, it's how much we're spending on AI and why we're doing it. And on the right side, it's going to say what we're going to get out of it in long term, both production and efficiency. So far, we're focused on production and effectiveness. But longer term, we certainly expect to get meaningful efficiencies and that including the function. So Jenny mentioned a lot of the front office and how we're utilizing it to be more effective there, but it's also across HR, finance, tech and itself. Risk management is another very important area internally where AI is being used very effectively already. So we've got a number of terrific opportunities and it's costing a lot, but I think we're going to get our money back and some in the out set months and years.

I mean to be honest -- the challenge with AI is -- you want to get your workforce to be comfortable using it. So you have to be careful about being too constricting on their use of it. On the other hand, it can get really expensive that people just start to write agents that are going to run. And so we're trying to balance that right now.

Great. If I could just ask a follow-up question. Just on tokenization, you've been an early mover with tokenized Money Funds, and you're having some early success there. And you've described wallets is becoming perhaps the next distribution channel for investment products. How do you think about the economics of that channel versus traditional wealth platforms? And does it ultimately expand the addressable market or maybe just shift for assets are held? And more broadly, if you could talk about your wallet strategy, how that might evolve over the coming years?

Sure. So, I mean the reality is this is just a programming language that has some real efficiencies in it. And we happen to know because when the SEC approved 5 years ago, our tokenized money market fund, they required us to parallel process. And so we were astonished by how much more cost effective it was. And I -- we go through all that detail here. But -- so in an industry where there's constantly pressure to reduce cost in products, we think that ultimately, honestly, financial services will be run on the rails of blockchain. However, it threatens a lot of business models. So that's going to be slower to roll out.

And you can't sell a tokenized product unless somebody has a wallet. A wallet is simply a crypto kind of receiver of the token. And so when we look at the distribution, our focus is sort of 3 areas in digital assets. One is distribution. Second is product capabilities. And the third is, how should we think about the underlying infrastructure that we've built to support things like the BENJI money market fund. And so on the distribution side, honestly, we're focused much more today on the entities that already have a wallet infrastructure. So those are -- if you just take the top 5 crypto exchanges, they have 1 billion wallets out there.

So the partnerships that we've done with MoonPay and Payward, which is the parent to Kraken, they want to take BENJI and integrate it because if you have a stable coin, you don't earn anything. People want to flip their money into earning yield. And so the only way they could do that if they're in the wallet infrastructure is to have a tokenized money market fund.

So we're focused on that, but they also want to offer their clients traditional investment products. So we now have tokenized money market -- sorry, tokenized ETFs or traditional ETFs. So we look at it as just another distribution channel. But we're also having conversations with a lot of the traditional distributors whose clients are saying, "Yes, I want to be able to hold some of my crypto assets in -- with my traditional products," and so they're looking at building the wallet infrastructure. But nothing that you build in the tokenization world can be sold unless you have a walled infrastructure. And the traditional players just don't have a lot of that today.

With respect to product capabilities, I mentioned the tokenize ETF, but like we closed on digital -- 250 digital, which is really -- think of it as like a venture firm for digital assets. And we have now had conversations with a lot of institutions that want to invest on exposure to that space weren't comfortable with a small shop and now that they're with Franklin Templeton, that they're now talking to us about much more meaningful investments there.

And then we -- this underlying infrastructure that we built, both the wallet as well as a shareholder recordkeeping system, we're trying to think through that. Is that something that we should commercialize? Or how should we think through it? So those are the types of things we're thinking about today in the digital asset space.

Our next question comes from Alex Blostein with Goldman Sachs.

A couple of things I was hoping just clean up. One, Matt, on the margins, when you talk about 2027, I believe your standard methodology, you don't assume market returns. So when you talk about 29% to 30% for 2027, exiting kind of north of [indiscernible]. I just want to make sure that assumes flat markets from here?

Yes.

Okay. That's great. And then the second, I don't think anybody asked about the capital return and the buyback, but pretty clearly a meaningful step-up in share repurchases this quarter. So maybe it's worthwhile just kind of fleshing out how are you thinking about buybacks from here and the capital management approach?

Yes. Thanks, Alex, for the question. So I'll make a couple of comments and maybe Jenny may want to add in some things on some of the strategic work. But look, number one, capital management as a whole. We are very focused on organic growth. As you know, as you grow the private markets business in particular, but it's the same with the public markets on a lesser scale. But in the private markets, you need to use your balance sheet to co-invest alongside your strategy. So number one, we have $3 billion now of our own balance sheet invested in funds, about $1.75 billion of that is private markets, $1.25 billion is public markets, and we see that growing into 2027.

Number two, we're always focused on making sure that we're in a position where we can continue to increase our dividend. That's a -- always a high priority, and we're going to continue to do that. Three is, we'll always repurchase our employee grants, make sure that our share count remains at least even.

And then four, as you alluded to, opportunistic share repurchases, in previous course in particular, over the last couple of years, whether it's being strategically active or working through the Western matter that's now behind us in negotiating the resolution, those things take quite a long time, and they can block you out of the market away from the usual blackout period. So now we have a lot more clear air, let's call it, intra-quarter where we're not naturally blacked out around earnings. So we're able to be more opportunistic in repurchasing our shares. And that includes the past quarter is a very good example where we repurchased $350 million shares.

Now this did include an opportunistic episodic, let's call it, repurchase from Great-West Life. We're in Great-West Life and Franklin announced the transaction where we acquired Putnam Investments and dialogue relationship with them. They announced a 4.9% long-term lockup, strategic investment in Franklin in exchange for the Putnam acquisition. And they made very clear to their investors, their intention to sell the amount above the 4.9%, and that's what we did in the quarter, they sold just over 1% of our outstanding shares. And we repurchased that from them. So that's one of the examples of why we were so high this particular quarter.

Fifthly, as acquisitions, we talked a lot about this. Frankly, it's a high bar because notwithstanding our improved share price. We still believe there's a lot of opportunity in buying back our shares. But it's strategically very active in the sector. We will only pursue areas where we are convinced that we can't grow fast enough organically ourselves, and there are areas where we need to be relevant and to be relevant if it involves acquiring something to et cetera, our growth in that area. We look very closely at it. We've already announced -- we're very interested in globalizing real estate. We're interested in areas involving distribution and partnerships and all those sorts of things, either involve acquisitions or investments in different companies that offer distribution opportunities for us.

And then lastly, is debt service. We haven't -- we spent quite a bit of time over the last 2 years in particular, delevering our balance sheet, we've got some outstanding on our revolver. We're thinking about accessing the long-term debt markets. We may do that in the next -- in the short term, let's say, here and refinance the revolver and then reload some cash on the balance sheet that we paid down, so we can accelerate various things in our strategic plan. So that's really the overview on capital management. I don't know whether Jenny, do you want to add anything to that?

No, I think you did a great job.

Our next question comes from Bill Katz with TD Cowen.

I was very keen on that margin update as well. But the broader question on that is you do seem to be running ahead of your 5-year plan. And two things. One is you mentioned possibly doing an Investor Day, I wondering you can give us an update on the potential timing of that? And then as you think structurally around the margin, what do you think is the endpoint opportunity for the industry? Because when I look at it, you're scaling, you're growing rapidly, you're leveraging AI and you're mixing your business to a more scalable lucrative businesses. Is 30% plus the endpoint? Or is that just to stop along the route?

I would say 30% is the stop along the route. The question is how quickly can you get there? And I -- and -- this is always a business where there is pressure for what do you pay in distribution fees and others. So those are the realities of the business. But I think our view is that we should be able to expand the margin over time above the 30%. And I -- honestly, Bill, I don't think any of us fully know what the AI impact is in -- anytime there's new technology, the first thing everybody does is they make more efficient what you do today. And it's only when you get it in the hands of your teams over a period of a couple of years, do people start to see sort of the new opportunities.

And so I don't know that any of us fully know the end state of what that looks like. But we are very optimistic where we're seeing it and using it and excited about its ability to be able to expand the margin. Matt, I'm sure you want to add some things.

The other thing I'll add, it's always a good opportunity to remind everybody just how much we've invested in our business. We often say that investment management, it's a capital-light business in terms of regulatory capital, but it's no longer really a capital-light business in terms of what you need to invest to be a winner and relevant in the most important things for our clients.

So I would say that where we've invested heavily in the last several years around ETFs, canvas, alternative assets, the wealth channel, these are quite significant numbers. And we're just getting to the point where we're realizing the potential of those things and getting margin uplift on those things. So I think as Jenny mentioned, 30% to 35%, I think, is the industry zone. But importantly, that includes where we've invested in the business, and there is some upside in that based on scaling what we've invested in. And the scaling is really important.

And as you know, some of those things have lower effective fee rates, but once they scale, they have really positive impact to the operating margin of the corporate. So we've been very focused on that.

In terms of the -- in terms of the Investor Day, yes, I think we feel like we're getting ready for an Investor Day. It will likely be sometime either this -- later this calendar year or early next calendar year as we get ourselves organized around it. But I think we have enough key areas to talk about in terms of our progress as a company. There's been a lot of transformational work that's happened, that now we have the outputs from those things and proof points and things like that, that we'd like to demonstrate more holistically. So yes, I think we're planning to do one. We don't know exactly when it's going to be later this year calender wise or early next year.

Our next question comes from Patrick Davitt with Autonomous Research.

Jenny, you mentioned the distribution expense pressure and there's news this month that Merrill Lynch is planning to make some fairly dramatic increases in revenue sharing platform fees. And it seems to be across a lot of product wrappers and that came after the Schwab news earlier this year on ETFs. So just wanted to get your updated thoughts on the risk that, that is becoming a bigger trend and that you could see incremental net revenue or expense headwinds from that shift?

Yes. I mean, look, rev share type programs have been around for a very, very long time. It is the nature of the business. What has changed a bit is the vehicles? And what has changed is that honestly, the influence of the end adviser, you even have large RIAs starting to talk about wanting to have some sort of share. And so I think it's a natural evolution of the business. And where a firm can influence distribution, then there's usually conversations kind of around it. And where they can't, you'll push back.

And so I don't really look at it as, obviously, if you're -- these platforms and there's more growth in SMAs and ETFs, there's going to look for some amount of platform fee, but the realities of the products is that can't possibly be as high as it had been in some of the traditional just because the distribution fees have adjusted. So look, we just kind of look at this business as usual, honestly.

This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's CEO, for final comments.

Well, thank you, everybody, for participating in today's call. And we remain deeply grateful to our employees around the world for their ongoing dedication and commitment to serving our clients. And we look forward to speaking with all of you again next quarter. Thanks, everybody.

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

Welcome to Franklin Resources Earnings Conference Call for the quarter ended March 31, 2026. Hello, my name is Nicole, and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions]

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

Good morning, and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings.

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

Thank you, Selene. Welcome, everyone, and thank you for joining us today to review Franklin Templeton's second fiscal quarter results. I'm joined by Matt Nicholls, Co-President and CFO; and Daniel Gamba, Co-President and Chief Commercial Officer. We'll take your questions shortly, but first, I'll highlight key results and themes shaping our business.

This was an excellent quarter for Franklin Templeton, with $16.9 billion in long-term net inflows across public and private markets, reflecting the strength and breadth of our diversified global platform. We delivered record gross sales and generated positive long-term net flows in every region, reflecting sustained client demand and strong local engagement. Importantly, each of our key growth drivers, private markets, retail SMAs and Canvas is our customization platform. ETF and solutions contributed meaningfully to these results. This quarter is a clear example of the power of our multi-year strategy in action. We are ahead of our 5-year plan and remain focused on delivering strong investment outcomes, deepening client relationships and continuing to evolve our capabilities to drive sustainable, long-term growth for our clients and shareholders.

In my travels meeting clients around the world, one message is consistent. Our clients look to Franklin Templeton as their trusted partner for what's ahead. One firm offering the reach and resilience of a global platform together with the distinct expertise of our investment groups. As client expectations continue to evolve, the more asset owners seek multifaceted partnerships with fewer firms that can deliver across asset classes, styles and regions. We believe our business is well suited to meet that demand.

We are seeing a clear structural shift in how clients allocate capital and partners, including increased demand for vehicles such as active ETFs, customization and tax managed solutions. [indiscernible] prioritizing firms that can deliver across public and private markets, offer global consistency in how they invest and operate and bring together capabilities into comprehensive outcome-oriented solutions. This is not a short-term reaction to market conditions. It reflects a more fundamental change in expectations for scale, breadth of capabilities and the ability to deliver them in an integrated way are increasingly defining competitive advantage.

Against this backdrop, we remain focused on executing as one Franklin Templeton. This means bringing together our strength as investment specialists, innovation drivers thought leaders and strategic partners seamlessly in every client interaction. To that end, we continue to simplify our go-to-market approach to better serve clients and capture opportunities across the business. Ultimately, our strategy center in helping clients to see better outcomes by staying focused on performance, solutions and partnerships. We are continuing to build a business that is more resilient, more relevant and positioned to deliver long-term value for our clients and shareholders.

Now turning to our results. This quarter marks another step forward in the successful execution of our strategy and reflects the growth potential of our business. We delivered another consecutive quarter of positive long-term net flows of $16.9 billion, driven by multiple diversified investment groups with continued progress across our key areas of investment and growth. This momentum is reflected in long-term inflows of $118 billion, up 28% quarter-over-quarter and 38% over the prior year quarter, excluding reinvested distributions.

Gross sales increased across all asset classes, highlighting the strength of our global distribution platform and the progress we are making across the business. Looking ahead, our institutional pipeline of won but unfunded mandates remained strong at $20.2 billion, consistent with the prior quarter, supported by steady funding rates and ongoing replenishment from new wins. Our assets under management of $1.68 trillion remains well diversified across asset classes, client segments, regions and investment groups. Public markets continue to be a core strength and an important driver of growth. Multi-asset AUM stands at $207 billion and generated $9.5 billion in positive net flows, marking our 19th consecutive quarter of positive flows in that asset class. These results reflect growing client demand for outcome-oriented comprehensive solutions that span public and private markets.

Across equities, net outflows were $4.7 billion. Investor activity remained selective, and we saw positive net flows across large-cap value and core systematic and single-country ETFs infrastructure and sector strategies. In fixed income, net outflows were approximately $300 million during the quarter. However, excluding Western, fixed income flows were positive $3.6 billion, marking a ninth consecutive quarter of positive long-term net flows. Momentum continued in multi-sector, munis, stable value and global fixed income strategy.

Turning to alternatives. Franklin Templeton is a leading manager of alternative assets with $283 billion in alternative AUM. Our breadth and scale continue to position us as a partner of choice for clients seeking differentiated sources of return and access to private markets. We fundraised $14.3 billion in alternatives this quarter, including $13.2 billion in private market assets, which was diversified across alternative credit, secondary private equity, real estate and venture funds.

Fiscal year-to-date fundraising in private markets reached $22.7 billion, already in line with full year 2025 levels, positioning us to exceed our $25 billion to $30 billion annual fundraising target, which was already adjusted upward start of our fiscal year. Within alternatives, private credit continues to be an area of focus. While market attention has increased, the opportunity remains highly differentiated across strategies and risk profile. Our alternative credit capabilities in the U.S. and Europe are focused on the middle market with a disciplined approach to underwriting and credit selection and include diversified portfolios that have less than 10% exposure to software.

Alternative credit represents $96 billion in AUM and was a significant contributor to fundraising this quarter. Looking across our broader alternatives platform, we continue to see strong momentum in secondary private equity, where investors are increasingly focused on liquidity solutions, portfolio rebalancing and access to high-quality assets at more attractive entry points.

We are also seeing a pickup in demand for private real estate, including in the wealth channel as investors position opportunities emerging from the current market environment. Franklin Templeton's private markets $8 billion core evergreen products spanning secondary private equity, real estate equity and debt and private credit continue to gain traction. These products had positive net flows contributing approximately $1 billion to fund raising in aggregate in each of the last 2 quarters. Across the platform, clients are increasingly engaging with us for broad and differentiated investment vehicles, and we're seeing that demand translate into sustained diversified growth.

ETF AUM reached a new high of $61.6 billion, a 67% increase from last year with $4.5 billion of net inflows, our 18th consecutive quarter of positive flows. Active ETFs now represent 45% of ETF AUM, further extending our active management strategies into new vehicles. This is evident in areas such as the conversion of 10 of our muni funds into ETFs in Q1, which generated over $600 million in positive net flows this quarter or the success of our Putnam focused large-cap value ETF, which is close to $10 billion in AUM. Delivery and personalization at scale continues to represent a compelling long-term opportunity. Advancements in technology are enabling us to extend capabilities traditionally associated with separately managed accounts more efficiently and consistently across a broader client base.

A leader in retail SMAs, we managed $168.3 billion in AUM and generated $2.7 billion in net inflows during this quarter. With more than 40 years of experience we are well positioned to deliver at scale through our breadth of capabilities along with our custom indexing platform Canvas. Canvas continues to gain momentum and reached record AUM of $22.9 billion, a 27% increase from the prior quarter with positive net flows of $5.3 billion, reflecting strong client interest and personalization and tax efficiency. Since its acquisition in 2022, Canvas has been net flow positive in each quarter and continues to scale across all distribution channels, supported by our over 200 partners and expanding adoption across retail, our AA aggregators and traditional RIAs. This growth underscores a broader shift in the industry where tax efficiency is becoming increasingly central to portfolio construction and the adviser client relationship.

Including Canvas, our tax managed products now represents $110 billion in AUM. As the industry evolves, we continue to invest in areas of long-term innovation and digital assets remain a key focus. Earlier this month, we announced plans to acquire 250 Digital, an active cryptocurrency investment management firm and to launch Franklin Crypto. Alongside Franklin Templeton digital assets, we are bringing together crypto-native expertise with Franklin Templeton's global distribution to target institutional growth. Franklin Crypto will expand Franklin Templeton's existing crypto and blockchain venture capital investment offerings and will broaden the firm's digital assets investment management platform.

From a regional perspective, our growth remains globally diversified with positive net flows in all regions. Internationally, Franklin Templeton manages nearly $500 billion in assets with a positive long-term net flows of $5.5 billion in aggregate. Non-U.S. gross sales grew 29% quarter-over-quarter with particularly strong momentum in EMEA and APAC.

As a leader in emerging markets, Franklin Templeton was appointed trustee and manager of the National Investment Fund of Uzbekistan in January 2025, supporting the country's privatization agenda and governance reforms across state-owned enterprises. In April, UMF confirmed plans to proceed with a dual listing on the London and Tashkent Stock exchanges marking an important step in advancing Uzbekistan's capital markets and broader privatization strategy. This engagement reflects our role as a trusted partner to official institutions and continues to drive deeper relationships with central banks, sovereign wealth funds and government-related entities.

Now turning to investment performance. Investment performance remains competitive, supporting both client retention and organic growth. Over half of our mutual fund and ETF AUM is outperforming its peer medium over the 3- and 10-year periods and approximately 2/3 over the 1- and 5-year periods. This strength is further supported by our municipal strategies, where 95% of AUM is outperforming its peer group over a 3-year period. Similarly, over half of strategy composite AUM is outperforming -- over all time periods and 71% in the -- In fixed income, 83% and 82% of AUM is outperforming benchmark mark over the 1- and 5-year periods, respectively, reinforcing the depth and durability of our investment capabilities.

Turning briefly to our financial results. Adjusted operating income was $475 million, increasing 8.5% quarter-over-quarter and 25.8% from the prior year quarter. These results reflect the continued execution of our strategy with disciplined expense management alongside targeted investments in areas of growth and innovation, positioning the firm for sustained long-term performance. Taken together, our performance this quarter underscores the strength of our platform and the progress we are making against our multiyear strategic priorities. We are building a more diversified, higher growth business with multiple drivers of organic growth, and we're seeing that momentum continue to build, positioning us to deliver long-term value for our clients, shareholders and employees.

I want to thank our employees around the world for their continued dedication and focus on serving our clients. Their efforts are fundamental to the successful execution of our strategy and the progress we're delivering across the firm.

With that, I will open the call up to your questions. Operator?

[Operator Instructions] Our first question comes from Alex Blostein from Goldman Sachs.

I wanted to start with a question around private markets growth. So obviously, good momentum in the quarter to $13 billion. I was hoping you could break that down by sort of key strategies as well as whether Lexington, their flagship fund contributed to that at all? And as you look out for the rest of the year, what are likely going to be some of the bigger drivers for the rest of 2026 in private markets fundraising?

Sure. Great. Thanks for the question, Alex. So as you recall, last year, we had set a target out of $13 billion to $20 billion in the Alt space arrays, and we ended up raising $22.9 billion, I think. And this year, we raised that to $25 billion to $30 billion just we would expect to actually be above the $30 billion. And when you look at this quarter, the -- and I can't give you any details on Lexington's flagship funds, but I'll give you some insights in it. Our largest contributor was actually our private credit managers, but Lexington was meaningful. Lexington is in the market with their flagship fund, and it is -- they're finding -- they're right on track there's demand for secondaries, but they're also in the market with other products they're co-investor middle market, which all contributed as well. There are no catch-up fees in this quarter. you'll get a specific update on Lexington's flagship fund when they do a filing probably towards the end of '26. All of our alternative managers contributed to this quarter's momentum. There are over 30 vehicles that contributed. So it's a very diverse, what we think is a strong quarter and we felt very good about the flows across the board.

Great. You saved me a follow-up on the catch-up fees there. I did want to ask about the comment you have in the release around just the dry powder. You gave us the total AUM [ $263 ] billion in private markets. Some of it is feepaying, some of it is not feepaying. So is it possible to break down like the non-feepaying piece and help us think through the timing of when that's going to come in into the fee rate run rate?

So -- it obviously varies with each manager. Alex, let us get back to you with kind of what we're willing to sort of say publicly on that. So we'll have give us a little bit here.

But Alex, fee earning AUM out of balance is about 90%, 89% approximately. Do you want to...

I think [Technical Difficulty]

Our next question comes from Glenn Schorr with Evercore.

So question maybe on Canvas and tax optimization strategy. Seeing a lot of growth you commented on yours. I'm just curious with -- there's a lot of competition, but there's also really low penetration. So I wonder if you could talk to about what you see for further growth in terms of penetrating the current base of clients, any capacity issues you might see? And then very importantly, how would you differentiate in a crowded field, meaning leveraging that brand and distribution relationship that you have?

Yes. So what I would say is, first of all, I think one of the differentiators of Canvas versus the others, I was like I said, it was built by quant people as opposed to tax people. And so it's much more about the technology, which gives a lot more flexibility going forward. And so I think Canvas is being selected in many cases because people recognize that it has the really kind of impressive technology. When we added the managed option solution over it, it's giving us a lot more creativity around product development. So things like you have high basis concentration of stock and you can use to manage options, component of it to be able to make a more tax-efficient portfolio. So we're -- I think we're winning because of the actual vehicle -- or not the vehicle but the technology there.

What started out as a direct indexing opportunity has evolved into an ability to take that technology as an overlay and create tax-managed, tax-efficient over active strategies. And so our conversations are now not just do you want this as a platform to manage separately managed accounts or direct indexing, but we'd love to use it as a way to optimize the tax efficiency of our active strategies. And so they're open up to a lot of partner conversations. I don't know, Daniel, do you want to add something to that?

Yes. So I will add two aspects to the success we're having actually on the tax alpha and tax optimization space, which is one space that's really growing very, very fast for the industry. And we're absolutely capitalizing on that. I'll say, number one, clearly, our retail SMA presence being so big at close to $170 billion makes us very uniquely positioned, including, of course, the legacy business that we have on the SMA side. And on the Canvas side, there's two elements to highlight. One is the tax optimization that we do is quite unique and differentiated because we do receive in-kind positions from -- to do that. And we're very flexible in how we do the optimization and clients are absolutely looking at that. And the other part is -- we add a lot of simplicity and we're very innovating. Canvas includes, as Jenny mentioned, not only direct indexing, but we also have risk factor overlays. We have options for income within the same platform, and we have added now fundamental third-party manager tax optimization, including for our different fundamental -- we're adding that. On top of that, we're adding long short or long short has already been built into that. We have 130-30, 140-40, all in the same platform. And finally, we also are having -- and we actually added already municipal bond ladders in the same platform. So the simplicity is giving us substantial momentum to the degree that it's actually grown at 72% CAGR, and it's grown actually 10x since acquisition at $23 billion. So I think the momentum will continue. The AUM doubled over the past 12 months, and we expect that to continue given how differentiated the platform is.

Our next question comes from Craig Siegenthaler with Bank of America.

Maybe if we can just move to the next one. We'll get Craig back on. It seems like there's a technical problem with that line.

Our next question comes from Dan Fannon with Jefferies.

Matt, I just wanted to follow up on the guidance that you gave. There's been some change from last quarter, but you also echoed reiterated the things you've been saying around flat with fiscal year '24 and '25. So wanted to just get us some clarification around the moving parts. And then also in the quarter, there was an announcement of some voluntary retirements across the equity portfolio or equity division. I assume that's incorporated in this guidance and maybe the outlook for next year, but just wondering if that's incremental or not?

Yes. The voluntary part is included in our full year projection. First of all, I don't go through the quarter guidance, and then I'll talk about the annual as part of that. So on the third quarter guide for our effective fee rate, we're guiding mid- to high 37s, so very consistent, stable with the second quarter. Compensation, we're guiding $830 million, assuming $50 million performance fee at a 55% payout. IS&T is $155 million, which is in line, maybe a little bit higher than last quarter based on AI investments specifically. Occupancy, we're at $70 million in the guide. And G&A, we expect to be a little bit higher at $210 million to $215 million, but this does include elevated fundraising related fees, but -- or expense of around $23 million, $25 million and an additional $9 million to $10 million for advertising and marketing.

In terms of the full year, as outlined on Page 14 that you referred to in the IR deck, this does assume flat markets from now and excludes performance fees. We continue to guide approximately in line or slightly above, slightly above fiscal year '25 expenses, excluding performance fees. This assumes current market levels, higher sales and fundraising that we've presented today and seen and stronger performance. Stronger performance, meaning we have some compensation-related expenses tied to better performance as formulaic driven. So that's going up a little bit. But for further perspective, we end up at the level illustrated on the page, which is about 1.5% higher versus 2025. We would expect investment management fee revenue to increase at 4x that rate at least. Meaning if the expenses increased by 1.5%, we would expect investment management fee revenue would be expected to increase by at least 6% year-over-year, all else remaining equal. And this is consistent with previous commentary on margin expansion going into our fiscal year end that would result in fiscal fourth quarter margin in the high-29s and for the year in the '27 for the full year, both representing meaningful margin expansion ahead of Plan and on our way to 30% plus margins later in 2027, all ahead of plan that presented last quarter.

Our next question is from Patrick Davitt with Autonomous Research.

There's been a lot of press focus on secondary PE strategies and the policy of marking up deals immediately upon close. Much of that has been focused on other companies, but could you give us more color on how much of Lexington's fund performance is driven by that initial markup versus natural appreciation? And then more broadly, do you see this increased attention or the increased attention on this practice impacting regulatory scrutiny or demand for the asset class?

The issue that happened there was actually because I think the manager kind of changed the policy and maybe was a little unclear in how that sort of went down. I think that created a huge amount of noise. Here's what. Traditionally the -- in secondaries, the markup, the discount markup is about 20% to 25% of total return over the life of a fund. So that gives you a sense for -- most of the appreciation really comes in the asset itself. And that's the beauty, I think, of somebody like Lexington, who's got -- is a premier buyer of these deals. They get to be pretty selective as far as what deals they choose and they have a ton of information. I mean they have information on 55,000 private companies. And so they're really tracking and getting to decide which underlying funds, they believe are going to have the best upside opportunity, and that's how they're really underwriting it, and then they obviously negotiated discounts. So that gives you kind of a sense.

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

I wanted to ask about AI. I was hoping you could update us on how you're using AI across the organization today. Some of the use cases that have been most impactful so far in some of the key learnings that you've had and if you're able to help quantify any of the benefits that you're seeing that would be interesting. And as you look out over the next couple of years, can you talk about some of the steps that you're taking to further embed AI throughout the organization. I know, Matt, you mentioned some uplift on expenses in part from AI investments, maybe you could elaborate on some of those investments and how you're thinking about longer-term benefits?

Yes. So we look at AI, look, having run technology. I don't think that there are many companies that they can sit there and say that the AI has yet to be material in their organization and everybody is doing a ton of stuff in it. So I'm proud of the work that we've done because we were early adopters in what is this multi-agent orchestration of AI, and that was the intelligent hub, what we call Intelligent Hub, which was our platform used for distribution.

The way if I were to bucket the AI efforts, I would say with respect to distribution and investments, it's all about growth opportunities with respect to operations and technology operations, it's about efficiencies and in technologies, it ultimately will be about getting more through the pipeline. So with this multi-agent intelligence sell start there, this is the one that we announced the partnership with Microsoft, and they came in and helped us build it. And I think it's a very simple problem with a complex technical solution. The simple problem is how do you ensure that your salespeople are seeing the right clients and having the best conversations. That goes in and it pulls data from your CRM system from your product system, external product systems, maybe social media. Those are multiple agents and LLM models tend not to be great with analytics, so you have to marry them with others. We are seeing early on uplift of our wholesalers our salespeople essentially seeing 10% more clients. I'm not going to share sort of the preliminary numbers, it's too early to sort of dictate whether that's translated directly into additional sales. But from just the efficiency of the administration, and it is looking like we are also getting an uplift in sales from those, and we're rolling that out more broadly.

Our investment teams are using it a little bit depending on the team, but we have hackathons done by our investment teams. They create agents. Those agents are put in the central library. We've been doing this for quite a while. I can't remember the number that we have. And so another investment team may decide, I'm going to pull this agent out. We also created a virtual research analyst that sits in one of our investment teams where they have fed in kind of the views of -- and the philosophy, and it will question it'll come up with sales or investment ideas and it will actually -- if you're thinking about making an idea, question like, have you thought about these things, you say these are important. And it's done a review of historical trades. And we have multiple different ways in which our investment teams are leveraging it and learning from it. The most important thing, I think, is we've created this centralized group to share expertise on AI so they get the learnings from each other. We have work -- this is something we're focused on to the extent that we've outsourced is looking at the length of our outsourced deals because we don't want just to have the AI efficiencies accrued to the outsourced still. So that's a part of our vendor management program. And then in places that we have the operations in-house, reconciliation, other things, RFPs, we are seeing some efficiencies. It's still very early and we're measuring in our technology group, for example, how much code is being written by AI. So that gives you kind of a feel for how we're using it across the firm.

Yes. In terms of how we're spending money, I mean, Jenny already touched on it, but to that question. We have a fully staffed dedicated team, as Jenny mentioned, that's centralized. But within that team, we have individuals focused on, as Jenny mentioned, investment sales functions, so that it becomes a fairly significant group internally. And then each of these groups is focused on both the effectiveness piece and the efficiency piece. So there's a revenue part of this, and then there's a cost part of this. And we're doing our best. It's very early days. We're doing our best to track the dollars we spend versus the dollars that we either save or that we gain through the process of using AIN adoption.

Our next question comes from Bill Katz with TD Cowen.

I just have a couple of nits added together, maybe equals one full question. On the tax minimization -- tax optimization side, there's been some discussion around potential adverse tax rule for Exchange 351. It seems a bit arcane to us, but it's been coming up a lot in investor dialogue. A, how real is that as a real change? Or is that more of a disclosure issue and would that have any kind of impact on the business?

My second question is just on Lexington 11. I think you previously raised $22 billion, and I know Matt just gave some guidance around some platform fees or placement fees into the new quarter or so. Is there any reason to think that, that next fund won't be equal of size? And then thirdly, just in terms of capital return, a little bit of fully question. Just wondering if you could talk a little bit about your priorities looking ahead?

I'll just quickly just jump on the Lexington and then I'll turn it over to Matt on the tax. So no reason to believe that, that is not at the size of the last fund. As I said, they are happy and on track, and there's good demand for secondaries. And we do not see any cannibalization with the evergreen funds that we've done in secondary. So I think that's going smoothly. Matt, do you want to cover the...

I think the everyone what was the tax -- 351, what was that...

Yes. It's a bit arcane, but apparently, in the index ETF world, there's some discussion between, I think, ICI and the IRS -- tech on this call. Just in terms of adverse ruling about tax optimization under the exchange. And would that limit maybe the use of options and so forth as a way to shield income but it's been coming up as a watch point given the really rapid growth in tax...

Here's what I would say, and I don't know specifically on that everything I am on the ICI Board, and we do talk a lot about -- The mutual funds have a sort of unequal tax treatment versus an ETF because you get to do the in-kind. I don't think -- there's always a worry that, that goes away. The reality is it's actually unfair. Why should your average person in a mutual fund who tends to be your smaller investor actually have to pay capital gains just because the fund experienced capital gains versus what their individual ownership is like they would if they owned a stock. So that has always been something that has been a disadvantage a bit on mutual funds. And I think that the ICI that that's one that's always discussed, I'm not aware of discussions about the ETF losing theirs as much as the hope with the ICI that you actually make the mutual fund more fair.

I will only add that none of our major ETFs use options overlays in the way in which they are constructed. So we haven't been hit with that question given the nature of our current ETFs that we have. We do have an excellent options capability within our SMA business, which we call most, and we've seen substantial demand on that. So on SMA is clearly on individual securities, there's no such discussion. But clearly on 351 Exchanges in ETFs, we are not part of those -- we don't have to products structured like that.

Yes. And actually, I just looked it up on perplexities and I have a better understanding what -- so there are people -- there are some strategies for high net worth where people will contribute and exchanges. And we have not really participated in that. That is one that you could and it could impact ETF share classes as part of a mutual fund. We'll see how that evolves.

Our next question comes from Brennan Hawken with BMO Capital Markets.

Two questions, just circling back on the alt fundraising. So thanks for providing the Evergreen AUM, which you've reached now. Maybe could you talk about what sort of flows you're seeing on a quarterly basis and how we should think about that? And then just a follow-up on Lexington. You referenced that you'd be giving an update at year-end. Can you help us understand why it would be year-end? Is that your updated expectations for the first close?

I think that the on Lexington, I think that they're -- like I said, they're actively fundraising. They'll decide kind of on the timing of their first filing. It hasn't been year-to-date, so it will be the second half or towards the end of the year.

Jenny, you made our fiscal year-end, now about fiscal year-end. Because -- that could be an update in July or something like that.

And then on the Evergreen, we have said that we're raising about $200 million a month across our 3 -- We have over $1 billion, we have 3 over $1 billion, and we're continuing to see that same kind of demand about $200 million a month into the 3 Evergreen strategies.

And that's remained consistent recently with some of the...

Yes, yes, yes.

I think important to say that we don't have a big BDC or large exposure to software within the platform. So we've continued to raise in line or even higher across all our evergreens. Secondary like real estate debt, real estate equity. So over the last 2 years, we continue to go in line with the penetration that we have on the wealth business. So substantial growth, and we haven't seen any slowdown from our end.

Our next question is with Ben Budish from Barclays.

Maybe just continuing to follow up on the alts fundraising. You mentioned, I think, earlier that most of it came from credit in the quarter, obviously, not from BDCs. Can you unpack a little bit what pockets of credit you're seeing the most demand? And then just a quick housekeeping one on the G&A. You mentioned there's some sort of onetime fundraising expenses associated with the larger flagships. Just curious if we should think about those as recurring or kind of near-term elevated, but maybe not in the run rate for next year or perhaps they come back with more flagship fundraising, any help there which would be great.

That's the expenses. I'll get that done quickly. That's really -- I wouldn't say it's onetime because you may have other quarters that also have elevated fundraising. But $23 million to $25 million is obviously a large number, and that would be onetime associated with good fund raise expectation with, let's call it, higher fee-type alternative asset funds.

So -- and on the alt fund raising, so we mentioned -- remember, on the credit side, we have both BSP as well as what was formerly Alcentra, but we're calling BSP Europe. So we had good strong fundraising for both of those. Part of it was CLOs, but honestly, there were probably -- remember, they have an opportunity fund. They have a real estate debt fund. They have special situation. So we got contributions from really across the board, and I think there's at least 15 different kind of funds that had some sort of contribution to the credit. It also -- I mean, interestingly, we're seeing clearing with real estate that's starting to pick up real estate and Clarion has tremendous performance there. But I think as people have been nervous and we're wondering, there's $20 billion in redemption requests on real estate managers out there. That money is probably going to go somewhere else. People like sorry, on the private credit managers out there, people like real estate because it not only gives a good source of income, it has a hedge, it's inflation hedge. And so I think that's why we're seeing this pickup in interest in real estate. And then our venture group has done well, too. So I think the key message here is this is a very diversified portfolio diversified -- rate as opposed to a real concentration. There are literally over 30 entities that raise money for -- in our alt space.

And I want to point one more point, Jenny, to what you're talking about, which I think this quarter, we've had positive contribution from every single region, which is very important. And in the old always, we have seen growing demand outside the U.S. with 40% coming from outside the U.S. sources, about 16% from EMEA and 23% for APAC. As an example, we successfully launched funds, new vehicles in Korea, Thailand, Taiwan, with a strong momentum in Japan, which is a key market for us given -- and we're putting increasing resources there. And in EMEA, we are now servicing 11 markets, which is like 5 more markets than a year prior given increasing demand for our LTEs across all 3 capabilities, including ventures.

And our last question comes from Ken Worthington with JPMorgan.

We're seeing ETF distribution fees being requested by intermediaries and being dismissed by some of the larger or largest ETF managers. How is Franklin thinking about ETFs and distribution fees? And do you see the potential for ETF access to drive market share shifts in ETFs potentially favoring Franklin?

Well, since Daniel's career started at the BGI at the early days of ETFs, so I'm going to let him answer this one.

Yes. So thank you for that question. I'll say that ETF is one of the most exciting developments that we have here in Franklin Templeton. Our platform reached $62 billion at the end of the quarter, and that's double what we have 18 months ago. Our flows, the organic growth of the flows just fiscal year-to-date, which is only two quarters, 49%, and we're growing really across the board. The three main drivers for ETFs, active ETF -- the industry is talking about it, 45% of what we have. It grew 70% relative to a year ago. We have reached our focused large-cap value ETF, is nearing $10 billion, and it's doubled in 6 months, and we have plans to launch every major fundamental PM with a large franchise will manage their own ETF.

The other part that I think is worth mentioning is we converted 10 muni mutual funds the last quarter. And now that's a full growth platform and is helping growth not only ETF, but also muni mutual funds, muni SMA, which is excellent. The other driver is single country and regional ETFs that represents 30% of the platform. They all had excellent inflows and we grow over 3 billion flows into these country ETFs, including Korea, Japan, Taiwan and keeping our heritage in managing local assets, we will continue to develop and launch more country and regional ETFs.

And the third driver is systematic and smart data that is 20% that is managed by our Franklin Templeton investment solutions. We have the Franklin international low volatility high dividend ETF approaching $5 billion. We will continue to do that. And clearly, we have a great track record on ETFs, and we are doubling down on that. Of course, a lot of our capabilities come from excellent relationships and partnerships with our clients. We have a U.S. wealth platform that is almost $800 billion and is one of the largest with hundreds of salespeople covering and educating our sales advisers. Of course, we review our business with all our platforms regularly. And as we evolve our platform and value to clients, we will prioritize our platforms that deliver the most value to us. So on the ETF discussions, we are clearly creating business plans with our partners. And those that have the most impact investing in education, sales and support and impact the business will continue to be major partners, and we will continue to discuss how can we grow our business together. So clearly, EPS is one of the areas where you're going to hear much more from us going forward.

And so just to the last point that Daniel is making. Look, platforms always want to have more revenue share, like that's just the reality. ETFs are not structured in the same way that mutual funds were and platforms, depending on the platform, they can influence growth and opportunity for ETFs or not. And so if the platform is actually going to be able to have some positive influence then that's a discussion we have to the extent that they can't influence ultimately in the end, then we wouldn't consider any of those fees.

Got it. And because some are not going to participate in or don't want to participate in the fees, do you think it drives share to shift from those that are willing to partner with distribution from those that are not?

Different platforms have different influence, right? And so if you can heavily influence? Yes. There'll potentially be some amount of shift on what you can influence. But the reality is the financial adviser is getting more and more independent. And to the extent that they're on one of these platforms and they're an RIA, they don't care what the platform is telling them. They're going to sell what they sell. And so it ends up being really kind of -- that's where having a huge work sales force is so important because it's hand-to-hand combat. If they choose the model from the platform, then the platform influences it. But most of the big RIAs who are big ETF users actually decide on their own.

Quick point of clarification from an earlier question that we wanted to just clarify. I think Alex asked the question around alternative asset versus nonfee generating. Just to be clear that 90% that we talked about approximately 90%, that's potential to earn fees on that. The fee generating -- current fee-generating AUM is about 80%, and that's on the full $283 million...

And it varies depending on bulk management so the blended.

Yes. I just wanted to make sure we clarify that.

Our next question comes from Brian Bedell with Deutsche Bank.

Great. Actually one on Franklin Crypto. Jenny, if you could just talk a little bit about what target market your -- what market are you targeting for that in the different product types as you evolve your Franklin digital assets? And then also on the tokenization of money funds to fund, your view on to what extent we'll see the development of tokenized money funds accelerate given obviously, the use cases in the yield cases, especially within the digital asset platforms?

Yes. Great. So first of all, why do I love blockchain because it's a really efficient technology that drives down cost. So that's a good thing for us as an industry and for our clients. But you have to have a wallet to actually hold a token, while it's just a cryptography that matches to that token, but you just have to have it. And all of our traditional distributors, very few of them actually have a wallet. So you have to go to the exchanges. So when you ask me where is the kind of immediate opportunity. It's an exchange -- a crypto exchange of cracking and a coin-based finance that have wallets there. And two things are happening. One is they're -- it's an obvious place to integrate Benji. So people want to put money into cash. If it's in their stable point, they don't earn any yield, so they can shifted into a money market fund and earn yield on that. So that's an obvious opportunity for us.

The second thing that's happening, and you just take the top 5 exchanges, they have 1 billion wallets there. So from a new client base, kind of interesting, and they're thinking about offering traditional products there. So we have launched, I think, 8 ETFs, tokenized ETFs on one of the exchanges and five on the other, and we're talking to other exchanges. So we've got 8 on Kraken and 5 on Onduo. And these are just in case those investors are interested in more traditional products. And so you couldn't hold an ETF or a mutual fund unless it was tokenized and because they have no other way of holding it. So we think that's an interesting new opportunity for us. And the other thing is you saw that we're bringing a small team, 250 Digital, and they actually are -- they kind of have institutional -- think of it as a crypto venture fund. And what we found is there are institutional investors who would like exposure to the space, but aren't comfortable with a small firm. And so now that they're -- we think that -- and they don't start until this fall. But when they start, we'll get some demand from institutional clients who are interested in investing in kind of a venture part of the crypto space.

And to the punchline, I guess, is that we should expect an acceleration of your tokenized products as you roll this out over the next few quarters, let's say?

Yes. I mean, look, these things are always a hockey stick, right? So right now -- it just depends on how much adoption, say, the tokenized ETFs get in the on those exchanges. We are seeing some traction where we are in programs where the Benjie product is an option, and we're starting to see some traction there. But I think it takes a little time to kind of sell people and educate on this space.

We think somebody was trying to get in earlier with a question on capital management. So why don't we just start to that we have time. So I think the question was on our capital management priorities. So I'll start and maybe, Jenny, then you can -- so the capital management priorities, we -- obviously, our dividend is always top of the list in that regard. We want to make sure the dividend is in place and continue to protect the increased dividend that we have each year.

Our organic growth is taking up more capital than it has done in the past. So I'll see capital and co-invest balance sheet allocation has increased again to $2.9 billion, up from $2.8 billion last quarter. As I mentioned in the previous quarter, we expect that to be close to $3 billion by the time we recent end of the year. We've always repurchased our employee-related stock grants to make sure we hedge our shares out to basically zero out for the year, to keep the same amount of shares outstanding. Then obviously, we have opportunistic share repurchases.

And then M&A is -- I think you all know, it's just very, very super active. There are some areas of focus here, mostly distribution related. I'd say, Jenny, may want to make some additional comments on this. But distribution related, a little bit bolt-ons related to alternative assets, in particular, overseas. We're quite involved in reviewing those things. But I'd say most of the M&A of inorganic activity is around partnership, strategic activity in connection with distribution.

Great. I think you covered it very well, Matt. Operator?

Okay. And this does conclude today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's CEO, for final comments.

Well, listen, everybody, thank you for participating in the call today. And once again, we are a people business, and I want to thank all our employees for their hard work and dedication to the company, and we look forward to speaking with all of you again next quarter. Thank you.

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

Welcome to Franklin Resources Earnings Conference Call for the quarter ended December 31, 2025. Hello. My name is Rob, and I'll be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions] I would now like to turn the conference over to your host, Selene Oh, Head of Investor Relations for Franklin Resources. You may begin.

Good morning and thank you for joining us today to discuss our quarterly results. Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements.

These and other risks, uncertainties and other important factors are just described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. Now I'd like to turn the call over to Jenny Johnson, our Chief Executive Officer.

Thank you, Selene. Welcome, everyone, and thank you for joining us today as we review Franklin Templeton's first fiscal quarter results. I'm joined today by Matt Nicholls, our Co-President and CFO, and Daniel Gamba, our Co-President and Chief Commercial Officer. We'll answer your questions momentarily. But before we do that, I'd like to review some key themes.

We are operating in a period of continued transition for investors, marked by significant market turbulence globally resulting from heightened geopolitical trade policy and consequently, economic uncertainty. Markets are adjusting to a more persistently volatile environment, shifting capital flows and a growing need for resilience in portfolios.

Across regions and client segments, investors are focused on the same fundamental questions, how to generate durable returns, how to manage risk through uncertainty and how to position portfolios for long-term outcomes rather than short-term noise. That environment is reshaping what clients expect from asset managers. Over the past few months, I've traveled overseas across Europe, the Middle East and Asia.

And in my conversations with clients, it's clear they are no longer looking for individual products in isolation. They're looking for partners who can help them construct portfolios across public and private markets, deliver personalization at scale and navigate complexity with discipline and insight. Franklin Templeton is well positioned for this moment. Over years of deliberate planning, combined with the strength of a global brand, we have earned the trust of investors around the world.

At Franklin Templeton, we bring together specialized investment expertise across public markets, private markets and digital assets, supported by a global platform with reach in more than 150 countries. Clients are increasingly engaging with us across multiple asset classes, reflecting a shift toward integrated solutions and long-term strategic relationships. This alignment between client needs and our capabilities is driving growth.

Our diversified platform continued innovation and focus on scale and efficiency position us to capture opportunities across market cycles and deliver long-term value for our clients and shareholders. Now turning to our results for the quarter, which marked another important step forward with tangible progress across the firm. We continue to deepen client partnerships, broaden our investment and solutions capabilities and strengthen our global platform, key priorities that remain central to our strategy.

Our first fiscal quarter continued the momentum, we built last year with strong client activity across Franklin Templeton's diversified global platform with positive net flows in both public and private markets. We had record long-term inflows of $118.6 billion, up 40% from the prior quarter and 22% from the prior year quarter. Long-term net inflows were $28 billion with record AUM and positive net flows across equity, multi-asset and alternative strategies as well as ETFs, retail SMAs and Canvas.

Excluding Western Asset Management's long-term net inflows totaled $34.6 billion, nearly double the prior year quarter, extending our track record to a ninth consecutive quarter of positive flows on a comparable basis. Assets under management ended the quarter at $1.68 trillion. AUM increased from the prior quarter due to long-term net inflows and the acquisition of Apera, partially offset by the impact of net market change, distributions and other.

Excluding Western Asset, long-term net inflows were $34.6 billion compared to $17.9 billion in the prior year quarter with 9 consecutive quarters of positive net flows. We continue to see strong momentum across our platform with record AUM in 3 of our 4 asset classes. Public markets remain a key strength and an important source of growth. Equity, multi-asset and alternatives generated positive net flows totaling $30.4 billion for the quarter.

And excluding Western Asset, fixed income delivered its eighth consecutive quarter of positive net flows. Equity net inflows were $19.8 billion for the quarter, including reinvested distributions of $24.6 billion. We saw positive net flows across Large Cap Value and Core, all cap growth and value, sector, international equity, equity income and infrastructure strategies. Fixed income net outflows were $2.4 billion. Excluding Western Asset, fixed income net inflows were $2.6 billion driven by Franklin Templeton Fixed Income.

Positive momentum continued in multi-sector, municipal, highly customized, stable value government and emerging market strategies. Our institutional pipeline of won but unfunded mandates remain strong at $20.4 billion, underscoring sustained demand for our investment capabilities. The pipeline remains diversified by asset class and across our specialist investment teams. Turning to private markets. Franklin Templeton is a leading manager of alternative assets with $274 billion in alternative AUM.

Alternative fundraising has been a key contributor to our growth with $10.8 billion raised during the quarter, including $9.5 billion in private market assets. Fundraising was diversified across our alternative specialist investment managers and reflected client demand in secondary private equity, alternative credit, real estate and venture capital from institutions as well as from the wealth channel. Aggregate realizations and distributions were $4.8 billion.

Lexington Co-Investment Partners VI, one of the largest dedicated global co-investment funds closed in October with $4.6 billion in committed capital. Today, Lexington's AUM stands at $83 billion, up 46% since its acquisition in 2022. In addition, we continue to expand our private credit platform with the October 1 closing of the Apera Asset Management acquisition. This strategic acquisition enhances our direct lending capabilities in Europe, growing lower middle market.

In January, BSP Real Estate Opportunistic Debt Fund II closed with $10 billion of investable capital, including related vehicles and anticipated leverage across $3 billion of equity commitments. Franklin Templeton's U.S. and European alternative credit businesses are now aligned under an updated Benefit Street Partners brand with $95 billion in private credit AUM at quarter end. Clarion Partners continues to be well positioned with a large, diversified portfolio and positive returns despite a challenging capital raising environment.

Capital flows remain well below historic averages, largely due to clients seeking more liquidity in private equity overall. Recent M&A activity in the industry underscores the importance of alternative assets, reinforcing the strategic rationale behind our acquisitions and investments and further highlights our ability to grow our alternative asset platform at scale.

Franklin Templeton Private Markets, our alternatives wealth management offering continues to gain traction and generated over $1 billion in sales for the quarter, underscoring the strength of our global distribution partnerships and client reach. Lexington Partners, Benefit Street Partners and Clarion Partners each have scaled perpetual funds totaling $6.7 billion in AUM.

These are semi-liquid perpetual vehicles open to ongoing subscriptions, giving investors efficient access to long-term private market exposure. Taken together, these capabilities are driving increased client adoption and strengthening our position as demand for private market solutions continues to grow globally. As investors continue to seek enhanced diversification and differentiated sources of return, private assets have taken on a more prominent role within traditional mutual fund structures.

We've been incorporating private assets into traditional mutual funds for over a decade. Today, we manage approximately 60 products, representing about $160 billion in traditional mutual fund assets that have exposure to private markets. Liquidity is closely and continuously monitored to ensure these products remain aligned with our traditional fund objectives. Multi-asset AUM is nearly $200 billion and had net inflows of $4 billion during the quarter, the 18th consecutive quarter of positive net flows led by Franklin Income Investors, Franklin Templeton Investment Solutions and Canvas.

These flows underscore clients' increasing preference for outcome-oriented diversified solutions across public and private asset classes, an area that Franklin Templeton continues to focus on and evolve through innovation. Clients are increasingly turning to Franklin Templeton for a broad and differentiated set of investment vehicles, and we're seeing that demand translate into sustained growth across our platform with record AUM across ETFs, retail SMAs, Canvas and investment solutions.

Our ETF platform continues to grow at a faster rate than the industry and reached a new high with $58 billion in AUM and generated $7.5 billion in net flows, marking its 17th consecutive positive quarter. The net flows were inclusive of $3.5 billion in mutual fund conversions. Our focus on active ETFs produced strong results this quarter. Active ETF net flows were $5.5 billion or approximately 70% of total net flows. Today, we have 15 ETFs that exceed $1 billion in AUM.

The industry conversation continues to shift toward delivering personalization at scale, and we see this as a durable long-term opportunity. Advancements in technology are allowing features of separately managed accounts such as tax loss harvesting, which were historically underutilized to be implemented efficiently and consistently across a broad client base. We are well positioned in retail SMAs with our breadth of capabilities, along with our custom indexing technology, Canvas.

As a leader in retail SMAs, AUM increased to $171 billion with $2.4 billion in net inflows driven by Putnam, Franklin Fixed Income and Canvas. Canvas generated $1.4 billion in net flows and reached $18 billion in AUM, reflecting strong client interest in personalization and tax efficiency. Canvas has been net flow positive since its acquisition in 2022. We are also seeing increased demand for multi-asset model solutions, including portfolios that combine both public and private asset classes.

This trend is extending into retirement channels where investors are increasingly seeking diversification, income and risk management through more holistic portfolio construction. Investment Solutions leverage our capabilities across public and private asset classes to pursue strategic partnerships. This quarter, Investment Solutions enterprise AUM surpassed $100 billion. Digital assets also continue to play an important role in modernizing financial infrastructure, and Franklin Templeton remains at the forefront.

Earlier this month, the state of Wyoming debuted the nation's first state-issued stable token with Franklin Templeton managed reserves, further demonstrating our leadership in blockchain-enabled investment solutions. Our digital asset AUM is $1.8 billion, inclusive of approximately $900 million in tokenized funds and approximately $800 million in crypto ETFs. Turning to artificial intelligence. We've made significant progress in advancing our AI efforts.

Yesterday, we announced the launch of Intelligence Hub, a modular AI-driven distribution platform powered by Microsoft Azure, building on the advanced financial AI initiatives announced in April 2024. Intelligence Hub delivers our vision for U.S. distribution by modernizing core activities, improving sales effectiveness and enhancing the client experience.

One of Franklin Templeton's strengths is our global presence, and international markets are an integral part of our growth strategy. We currently operate in over 30 countries, and our international business continues to expand with positive net flows for the quarter with strength in EMEA.

Now, in terms of investment performance, over half of our mutual fund and ETF AUM is outperforming its peer medium across the 3-, 5- and 10-year periods. Similarly, over half of strategy composite AUM is outperforming its benchmarks over the same time periods. Compared to the prior quarter, mutual fund investment performance increased in the 5- and 10-year periods and declined modestly in the 1- and 3-year periods due to select U.S. equity strategies.

On the strategy composite side, investment performance improved in the 10-year period, was stable in the 3-year period and declined in the 1- and 5-year periods. The 1-year decline was primarily driven by the liquidity strategies. Overall, long-term performance remains competitive and continues to support both organic growth and client retention. Turning briefly to financial results.

Adjusted operating income was $437.3 million, reflecting lower performance fees and the annual deferred compensation acceleration for retirement-eligible employees, partially offset by the impact of higher average AUM and realization of cost savings initiatives. We remain disciplined in managing expenses while continuing to invest strategically in areas of growth and innovation for the benefit of all stakeholders.

We are confident that our diversified business model, global scale and client-first culture positions us well to capture the long-term trends reshaping our industry across public and private markets. Finally, in December, Franklin Templeton was once again recognized by Pensions & Investments as one of the best places to work in money management. I'm proud to lead such a talented and dedicated team, and I want to thank our employees for their continued hard work and commitment to serving our clients. Now let's open up the call to your questions. Operator?

[Operator Instructions] And the first question is coming from the line of Bill Katz with TD Cowen.

Thank you for the extra disclosure in the supplement around expenses. I think that was quite welcomed for sure. Maybe on that, just a 2-part question. To the extent that the markets were to be a bit under pressure as the year goes by, how much flex do you have to sort of bring that number down? And then secondarily, I think in there, you sort of affirmed you're going to get to $200 million of cost savings. Could you speak to maybe the residual amount yet to be realized and the time line against that?

Bill, it's Matt. So as outlined on that page, thanks for highlighting it in the investor deck, at flat markets, as we mentioned in the assumptions and excluding performance fee comp, we do expect expenses to be in line with 2025. This is inclusive, again, as we also outlined on that slide, of our key investments that are essentially offset by the expense savings.

From a modeling perspective, if you take the guidance, which I can give on the second quarter and then you add that to the first quarter, take those -- take that sort of combined number for expenses and then take the last 2 quarters and divide it roughly evenly between the last 2, that will get you where we believe we'll be at this point in time. It may be that the expense saves shift a little bit between the third and the fourth quarters, but that's how we expect things to play out in terms of our cost savings.

And that is, of course, as I've mentioned in the past, in conjunction with margin expansion, in particular, going into the third and fourth quarter. So I think for the second quarter, you won't see much of margin expansion. You'll see that going into the third and fourth quarters where we expect to be, again, given current markets, given current AUM levels, we expect our margin to be getting into the high 20s at that point from where we are today.

The next question is from the line of Craig Siegenthaler with Bank of America.

My first question is on the recent M&A activity. I know you've been very active. And I wanted to see if you had an update on potential contingent consideration liabilities because I see there's only about $20 million in the new 10-Q that you put out today, but I actually thought it was larger than that. So is that really it? And -- or could there be more especially with the deal you just closed last quarter?

No, that's the contingent consideration around specific transactions that we've done. So it's really virtually nothing at this stage. What that doesn't include is some compensation related to transactions, but that's all in the compensation line and all included in our guidance. So -- and some of that, you can see in the GAAP versus non-GAAP disclosures for specifics. But for transaction-related consideration, it's a very low number that's left, and that's probability weighted, Craig. So yes, nothing additional to report there.

Okay. And just one question, right?

Yes. Well, I think you had -- you want to ask something else about M&A? I think, Jenny, do you want to cover the M&A question?

Do you want to just -- sorry, Craig, are you asking about what kind of our view is on M&A? Or what's your question on that?

Actually, I did in the first part, but if you want to kind of update us on your M&A priorities, product gaps, kind of where you're looking, where you see kind of strategic benefits, that would be helpful, too.

Yes, sure. So it hasn't really changed. I mean what we've always said is we do M&A for strategic purposes, and they're usually around whether we need to fill out an obvious product gap. Today, honestly, we are pretty full. I mean the one area that we had said was infrastructure. You need a lot of scale for infrastructure. And we feel like we've filled that at least for now with the partnerships that we've done with the 3 infrastructure managers, and we're focused on the wealth channel there.

Any kind of M&A we do going forward is going to really be in 3 areas. It will be like what we did with Apera, which is to fill in a specific bolt-on area either geographically or capabilities to our alternatives manager. So in that case, they gave us European direct lending, which we were able to combine with Alcentra's direct lending group. And I think we're now at $10 billion in European direct lending there. So that's kind of a bolt-on, both geographically and capability.

And then the second area would be if it somehow furthers distribution. So we've done either investments or actual M&A that help us like a Putnam deal where we also brought with it some sort of distribution capability. And then the third area is really in high net worth. We've said we want to grow -- we want to double the size of fiduciary in our 5-year plan, and that can be both -- that will be both organic as well as inorganic. So those are the kind of 3 areas that we're focused on.

And I'll just add something to this, Craig, that it's almost reiterating what we said in the past. But look, what we've done in M&A as a company has transformed the business. It's almost 60% of our operating income that's been added over the last several years through M&A. And I think that we're a bit of a modest company at the end of the day, but the timing of our private markets acquisitions was quite good. And as you know, we've been growing the multiple down very substantially in terms of those transactions.

So we're very comfortable with M&A. And as Jenny mentioned, we've got some things that we're reviewing. We're kind of in the strategic flow would probably be an understatement. But right now, the return on M&A is very important to us. We have high bars. And obviously, given where our equity is trading, the bar is even higher for M&A. So the first thing we look at is what's the return on buying back our shares relative to what we could get from M&A or providing more seed capital and these other things around capital management.

The next question is from the line of Brennan Hawken with BMO Capital Markets.

Matt, I don't think I heard it in the prepared remarks. So I figured I'd drill in. Would you have any expectations for EFR either both in the coming quarter? And then if you have a view maybe for the balance of the year, I know you've got the Lexington flag-raise is expected to start. I'm guessing that will help.

Yes. I'd say that for the next quarter, we expect EFR to be stable where it is today. And then in the following 2 quarters, there could be some upside to that based on fundraising around alternative assets as you've just highlighted.

The next question is from the line of Alex Blostein with Goldman Sachs.

Matt, I was hoping you could expand the margin discussion a little bit longer term. Franklin has done a really nice job integrating a number of assets over the years. Good to see the expense flex come through. But when you think about the operating margins for the firm as a whole, kind of running in the mid-20s, to your point, maybe entering high 20s towards the end of the year, where do you see the profitability over time? Many of your peers are well in the 30s, kind of mid-30s percent range.

So knowing what you know about the business, knowing what else might be on the come with respect to integration of some of your managers. How should the Street think about profitability over kind of a multiyear basis? And what's kind of the goalpost there? And maybe just a clarification. I know you said high 20s margin exiting 2026. Is that with market? Or is that also assuming flat markets?

The latter one is flat markets. So it's part of our guidance from where we are today. In terms of the first question, we put out there a 5-year plan where -- and we've got 4 years, well, 3.75 years to go of that plan. And we said we'd be in excess of 30% by the time that's finished. The reality is we are well on our way to the 30% margin, all else remaining equal going into 2027, let's say, fiscal 2027. So sometime in 2027, we'll be there.

And then if all else remain equal around the market, as we've said, there isn't any other reason why we couldn't be somewhere between 30% and 35% if we achieve all the goals that we put into our strategic plan that we've highlighted to the -- to all of you and as we highlighted, where we're at against that at the end of last year. So yes, that's where we're at on the margin.

As I mentioned, where we should end this year, all else remaining equal, in the high 29s going into 2027 fiscal at some point would be 30%. And then if the market stays where it is today, we should go in excess of that in future years where we thought we'd be more like 30%. So we have some upside there.

Remember as well, we do have the highly episodic situation around Western, where we've been providing support to the Western expense structure since August 2024, which has had an impact on our overall margin as a firm, probably several points, so we'd already be in the high 20s or 30% now, excluding that. But we've done the right thing in our opinion, by providing that support. And by definition, also supports future growth opportunities that we've highlighted in our 5-year plan.

Our next question is from the line of Glenn Schorr with Evercore.

Jenny, I felt like you had strong conviction in how you talked about -- you said something like no longer -- people -- clients are no longer looking for products in isolation. Curious how much you were leaning towards the institutional versus the wealth side? And more importantly, how are you organizing around that? How do you deliver it? Is it your own model that is getting on other people's models? And is it also bigger strategic broader relationships with LPs? I'm just curious to flesh that out a little bit.

Yes. No, great question. So that comment is both a wealth comment as well as the institutional comment. So you talk to any of the big wealth platforms and what they're basically saying is we -- there's more demand from their clients to offer truly what used to be just available to high-net-worth people. So it's financial planning, tax efficiency, education, education of the heirs. And so what their message is, look, we're going to consolidate to fewer managers.

So we're going to look at the ones that have scale, that have breadth of capabilities and can offer these additional services to us. And part of that -- so I'm talking first on the wealth side. And part of that on the wealth side is if you have traditional and privates, show me that you can support us on the education of the sale of our private. That's why we have 100 people whose sole job is to support our market leaders out there as they meet financial adviser by financial adviser from an education standpoint.

And so really focusing on streamlining on the wealth channel. We're having the same discussions on the institutional side, where the conversations are around, okay, show me your broad breadth of capabilities. I want to be able to second some of my more junior folks, show me how you can build a program around that, that goes across market. So fixed income equity, secondaries, private credit, like we want that education across and that you will support those types of programs.

And again, they're consolidating the number of managers. And you have to remember, you have a blow up with one manager, it taints your firm's reputation. There's as much due diligence on a multitrillion dollar manager as there is on a single $20 billion manager. And so the amount of time that they have to do in doing due diligence on the managers, making them want to consolidate, just use larger managers and expect more from the manager. So that's both, like I said, institutional retail.

We've seen it on the insurance side, where as they're looking -- you have this trend towards leveraging sub-advisers. They want broad breadth of capabilities there. So we're seeing it on -- as you talk to retirement managers, show me the breadth of capabilities that you have and show me how you can help support the business. So I would say this trend has been going on for the last few years, and it continues. And we feel really well positioned for it.

I wanted to add a comment into Glenn's comment on actually our success, especially on the wealth space, which you mentioned, we have over 100 odd specialists that complement the field and the wealth people on the ground. And the success that we've seen actually over the past year alone, we've increased substantially the amount of AUM that we fundraise in the wealth space. And we expect that, that's going to be between 15% and 20% in 2026. But also importantly, 40% is coming outside the U.S.

So it's also growing outside the U.S., both in Europe and Asia. And we -- the other part that is important is over the past 2 years alone; we built 7 perpetual funds that are close to $5 billion in fundraising and the fundraising is just going up every quarter. So this quarter is 50% higher than the quarter before, and the momentum continues because we continue to sign up new wealth groups.

And to your question, Glenn, we're also starting to build those model portfolios of perpetual funds that will continue to accelerate the growth on the wealth. So that's an area of focus, and I think that's an area of a lot of success from, frankly. So I just wanted to add that to the conversation.

And you just remind me, Daniel, Glenn, you asked the question about do we also try to get in other people's models? Yes, the answer is we do. As other people have both CIO and their open architecture, and we are in that case, in other people's models. So our goal is to meet the client, however, we can meet the client, whether it's whatever vehicle, we're vehicle agnostic.

I think that you would see that all of our flagship products are being sold in multiple vehicles. So some form of ETF, mutual funds, CIT, SMA, we're adding tax efficiency to our active SMAs. And so having that flexibility is really important as they select you as one of their core providers.

Our next question comes from the line of Dan Fannon with Jefferies.

So Matt, I wanted to follow up on some of your comments around long-term margins and the expenses. So just thinking about expense growth beyond this year, are you -- can you give us a sense of how you're thinking about that? And do you anticipate in those longer-term targets for margins additional cost savings and/or cost programs that will help you get there?

I mean it's possible that we're deep in on AI. We're deep in on how to maximize our presence that we have in India and Poland, for example, where we've got very large operational capabilities and great talent in these places. We're working on meaningful integration across the firm to maximize and capitalize on what we've got here. Every time when we progress down one of those paths, we find other places that can, frankly, absorb areas that we need to invest, at least absorb.

What we're demonstrating this year is a meaningful increase in margin, all else remaining equal and an acceleration of our plan to get to 30% plus. And we're doing that through very disciplined expense management whilst continuing to invest in the business at the same time as the market going up. So we've got meaningful investments for growth. We've got the market that's meaningfully up, yet our expenses are staying flat to last year.

I think going into 2027, obviously, look, we're not -- we're only a quarter through 2026 fiscal. But I feel confident that going into 2027, that a lot of the other initiatives we have going on will help to continue to absorb the additional expenses that are required to grow and invest in our business. But obviously, we can't comment reliably on fiscal 2027 when we're not even through '26.

But I hope through these comments, when you look at how we've performed from an expense perspective, '25 versus '24 and now what we're guiding in '26 versus '25 that we've mostly achieved what we said we're going to achieve even with upward momentum in the market. So I do think we've got some room in the numbers in terms of further cost saves going into fiscal '27 based on everything that we know. But right now, we're focused on delivering on fiscal '26 as we've highlighted.

Yes. And I'm just going to add, Matt, like when we think about where is there upside opportunity on margin, I'm going to throw it into kind of 3 categories in the shorter term, but sort of a '27 on. One is streamlining the products. We've done a lot around. I think almost 1/3 of our products we've looked at and either repositioned, merged, a few cases closed and in some -- when I think about repositioning, it's like turning them into ETFs. We did big ETFs conversion where we think they'll get more upside potential.

So as we determine that, there's opportunity there. The second is it always takes a lot longer. And you think about all the acquisitions that we've done, we kind of say, I think, 11 acquisitions in the last 5 or 6 years. But the reality of Legg Mason was like an acquisition of 5 companies or 6 companies, not 1 company because they were all on their own systems. They had their own versions of CRM, different CRM systems. That is still ongoing. And those -- and some of that's built into the projections that we have.

But some of it, you continue to uncover more opportunities there as you integrate. And it takes multiple years to do the full integration. And so that's still working. And then finally, like AI and technology, we think blockchain is going to be a great efficiency adder as it's adopted out there. But like AI, just you may have seen that we announced this intelligence hub. It's one area that we're working on AI to make our distribution people more effective.

What we saw is the time to finalize call lists dropped 90% when we rolled this out. Now what does that -- it went from 3 to 4 hours to 15 minutes and the prepping for meetings dropped from 6 hours to 2 hours or something per week. But those are small little incremental cost savings or hopefully, more importantly, what it's done is actually added 9% to 10% increase in the number of meetings that our distribution team has. So hopefully, that translates into more sales.

But think about that as you're rolling it out. We've already talked in the past about AI and the improvement in our RFPs. We're doing a lot of work on our investment side. It will either translate into growth opportunities or it will translate into cost savings. But honestly, it's a bit hard today to build that into direct cost savings opportunities that expand into the margin. But those are big opportunities, we think, going forward. And we are very focused, we think on the AI side, we're actually leaders in that space. So I just want to add that to kind of Matt's comments.

And then finally -- Jenny, thank you for that. And then finally, most of the stated growth areas that you can see as demonstrated by our positive flows in them are scaling. They're scaling up. And in particular, ETFs, Canvas and solutions, for example, each of those 3 areas for us. So obviously, they're lower fee and when they're smaller AUM when you're growing, overall as a business, you have a lower margin as a result of that investing to grow the business to a scaled position.

What's happening now in terms of ETFs, Canvas and solutions, in particular, notwithstanding the lower fee rate associated with those vehicles, those businesses, let's call it, they're getting to the point now where the size of them and certainly going into later into '26, '27, all else remaining equal, we expect the scaling of those businesses to create higher margins overall. So you have a lower fee rate. I know everybody is very focused on the fee rate.

But at a certain point when you get above a certain AUM, expenses are very managed and -- because you've done all the investments, you've got the team you need. And then you could be 2, 3x the size of AUM and therefore, have a much higher margin. Similarly, in our alts area, as we continue to grow significantly across all 3 of our -- 3, 4 of our primary alternative asset's businesses, we're getting more margin from that. I mean the $10 billion that Jenny talked about earlier on the $9.5 billion of fundraising doesn't include, for example, Lexington Fund XI. So it's important to note that.

Our next question comes from the line of Ken Worthington with JPMorgan.

I guess pressing AI further, Jenny, you've been in the press talking about the impact that AI has on asset management, suggesting that it could drive, if not accelerate more consolidation in the asset management industry. So maybe, one, how does AI drive consolidation? And then two, from Franklin's perspective, how would AI sort of alter your ability and willingness to do the M&A transactions and fill in the gaps that you mentioned sort of earlier in the call?

Yes. So a couple of things. So one, my comments on M&A consolidation has been really what I said is, look, if you haven't -- if you're a traditional manager and you haven't already purchased scale in alternative managers, it is going to be really difficult to compete going forward, especially because, one, that comment on distributors trying to consolidate, so they're demanding more from you.

Two is, as Matt pointed out, we were fortunate that we are very early in these acquisitions, traditional -- alternatives managers have gotten incredibly expensive since we did our acquisition of BSP and Clarion, and it will be very, very difficult to be able for a traditional manager to be able to go out and acquire. #2, this convergence particularly in fixed income, you're going to see, but across the board with products that are -- that have -- that contain both private and public in them.

If you don't have that under the same roof, roof, we don't think you're going to get the same kind of just synergies that you get from learning and managing and research. We have over 50 products between Western, ClearBridge and Franklin. Franklin has been doing private markets in their traditional mutual funds for over a decade. So over 50 products actually have privates in them today. So we already have that in our mutual funds. So one is in the alternative space. The second is AI.

AI, the amount of data required to truly train a model is really significant. And if you're a smaller manager, one is you won't be able to buy -- you won't be able to buy the kind of data. We spend hundreds of millions of dollars on data. And so to be able to scale that data plus the data you generate internally across all of your different capabilities is really important in training models. And it's just going to be hard to compete on training those models if you don't have a scale.

So that's where -- why my comment was, I think that's going to drive some consolidation because I think over time, we're already seeing it. Now look, any time you have technology breakthroughs, first thing people do is just make more efficient what they do today. That's why we give you quotes like, hey, we're more efficient on the call because it's hard to measure the actual value-added output because that doesn't happen right away.

It doesn't happen until you start to put in the hands of your people so that they can build those ideas. I love to say it's like when the iPhone came out, we all looked at it as this is a pretty cool camera and flashlight and whatever. It was unleashing the hands of the public that came up with all these creative applications. As you start to train your workforce on how to leverage agentic AI, which we were very early adopters of broadly rolling out ChatGPT, and we do trainings on how to create agentic AI.

We do hackathons with our investment teams, and it's a cross-functional hackathon. So we put people together that are across various teams to say, go build agentic AI. And they're doing things that are built one on top of the other. And then we take them, and we test them across others. So to me, the ability to do that and compete is going to be very difficult if you are small and in particular, if you are singly focused on kind of one area of the capital stack.

Our next question comes from the line of Michael Cyprys with Morgan Stanley.

I just wanted to come back to some of your commentary, Jenny, on blockchain and tokenization. Just curious if you could talk about your strategic objectives for that over the next couple of years. What steps are you looking to take here in '26 to enhance your positioning to help improve adoption, for example, of your existing tokenized funds? And then to your point on efficiency, I guess, how do you see blockchain contributing to improved efficiency at Franklin? How much lower cost is it to operate tokenized funds versus your traditional funds and rails?

Sure. So I'll tell you, like this is just an incredibly efficient technology. And my -- the best example to give you an idea of how it become -- how I think it's from a cost savings standpoint, how significant it is. I'll start there and then kind of what the opportunities and the hurdles are to more broad adoption. So the first thing is when the SEC approved our Money Market Fund, they had this parallel process.

It was something like we did over a 6-month period between our old transfer agency system and our blockchain system. And we were one of the few firms that were still running the transfer agency system in-house. So we got to see that comparison. And we did about 50,000 transactions. It cost us about $1.50 per transaction, cost us $1.13 to run it total to run those 50,000 transactions on the stellar blockchain. We picked the right chain. There's a lot that goes into that.

But it showed us the dramatic difference in cost. And today, if you open an old Money Market Fund, you need $500 to open up because below that, we probably lose money, and the other shareholders subsidize you. In the case of blockchain, you could open a Benji, you downloaded the Benji app and open a Money Market Fund, you would -- you only need $20, and we could probably go less than that. So it's cost savings.

The second thing is there's a huge amount of cost in financial services that's just reconciling data between your own systems and then reconciling with your counterparty. All that goes away when you have a single source of truth that is updated immediately. So those -- that's where you're going to have cost savings, which is why I believe it will fundamentally replace all of the rails.

There's a lot of toll takers in the system today that will slow that down as much as they can because it threatens their business model. But water runs downhill no matter how many obstacles you put in it; it will become very significant. So why the slow adoption? You cannot hold a tokenized product without having what's called a wallet, okay? Now it's a blockchain wallet.

It's merely an encryption key that's your own personal one, but you can't hold any of those -- in the U.S., in particular, where you had -- you didn't have regulatory clarity until the Genius Act came in, there was no point in any of these big wealth advisers on the traditional side to even think about it because it was kind of like the third rail from a regulatory. I can tell you this year, I feel like is completely changed.

You now have the large crypto exchanges interested in trying to offer traditional types of funds, ETFs and others that would be tokenized. And you have the big traditional managers who are saying, can you please educate us on how we access the space, how do we build a wallet, what's required there. And so I think you're going to start to see much greater convergence between TradFi and DeFi.

We -- our tokenized Money Market Fund, what we see is if anybody's been involved in securities lending, you know that people will move who they'll borrow where they can get the highest collateral return even if it's a basis point. Why would you keep there's $300 billion in stablecoins? Why would you park your money in a stablecoin that doesn't give you a yield when you could move into a Benji money market fund, earn that yield and when you want to do a payment transactions, convert into a stablecoin.

We think by the end of March, we will have the ability for somebody who has a stablecoin where Benji has been integrated with multiple different stablecoins, where on these crypto platforms, we announced a partnership with Binance, we have with OKX and Kraken and others, where you'll be able to convert from your stablecoin into our money market fund and on a Saturday, convert out if you want to leverage it for payment and earn that yield.

And again, because it's on blockchain, we actually pay you that yield in your account every day. If you're a corporate treasurer and you can get use of those funds every day versus accruing and waiting for that capital to be paid to you at the end of the month on a Money Market Fund, that's going to be a benefit. And so that's where we think there's an opportunity, but Benji is just the beginning of where we think this goes.

Our next question is from the line of Patrick Davitt with Autonomous Research.

Following up on the expense guide. I don't think you've ever talked about the scale of this third-party performance-related expenses you're excluding. So could you give how much that runs each year? And then I think, Matt, you hinted you have a detailed rundown of next quarter expenses you can give?

Thanks, Patrick. That should be -- the third-party piece should be relatively small. I'll check with the team quickly just in case. But that was -- that larger performance fee that we had to run through G&A last quarter was associated with a large performance fee we got from BSP, and it was for previous employees. So but I'll get what that number could be going forward. In terms of -- but it will definitely be smaller.

In terms of the third quarter -- sorry, second quarter guide, I already mentioned EFR, we expect it to be in line with this quarter. And as I mentioned, the last 2 quarters, we have some upside potential in EFR related to potential fundraisings in alternative assets. Comp and benefits, we expect to be around $860 million. This includes $30 million of calendar year resets for the 401(k) payroll, salary increases and so on.

It also assumes $50 million of performance fees and a 55% performance fee compensation ratio on that. IS&T, we expect to be $155 million, consistent with last quarter. Occupancy, $70 million, again, consistent with last quarter and as we've guided in the past. G&A, $190 million to $195 million, again, in line with the previous quarter. This assumes a little bit higher fundraising expenses and a little bit higher professional fee. And then the tax rate, we guided last time for the year, 26% to 28%.

We're keeping that guide, but we're now on the lower end of the guide or low to mid, let's say, in that guide. So we're bringing the guide down on taxes for the year from the higher end, which I think I said last quarter to the lower to mid part of that guide. And then really importantly, I just want to reiterate for '26 because I know you'll be calculating back what should -- how do we get to the flat expense guide, all remaining equal and excluding performance fees and the other assumptions we put in the deck, how do we get to that guide?

I would add the quarter I just gave you to the first quarter and then look at the last 2 quarters and just spread the expense savings over those 2 quarters. We recognized about 20% of the $200 million in the first quarter, and we expect to spread the rest of it out over the next 3, but there'd be larger amounts of it in the last 2 quarters. And again, we expect to end the year in a very similar expense position as we were to '25 notwithstanding all the investments that we've talked about making in the company and at a higher margin, as I mentioned when I answered Alex's question.

Our next question comes from the line of Ben Budish with Barclays.

I was wondering if you could maybe talk a little bit about the equity flows in the quarter. I know calendar Q4 is typically seasonally stronger. And obviously, there's been a trend of improvement over the last couple of years, but this quarter looked particularly strong. Anything unusual or onetime to call out? Or does it -- was it more broad-based? And I know it's still a bit earlier in the fiscal year, but any thoughts on how the rest of the year may shake out would be helpful.

I'll start, and then I know Daniel will want to jump in. I mean, obviously, it's a quarter that you have strong reinvested dividends. So that is part of the flows, which is important. But I have to tell you, I mean, Putnam continues to have excellent performance and continues to have very, very strong flows. And honestly, that has even continued into January.

I don't want to steal the thunder here and January hasn't closed yet, but we actually are looking like we will be positive net flows inclusive of Western, which has been a long time since that in January. Now again, I caveat that since it hasn't actually closed today. But part of that has just been the strength of Putnam. Daniel, do you want to add?

I think it's -- I think you got it. I will say it's a combination of Putnam, clearly on large cap value, on research, also on emerging markets, we got some institutional flows from our Templeton Emerging Markets capability, which is very, very encouraging. And I will also say our ETF franchise had excellent results, especially on the active ETFs, which is also a combination of the results from our Boston affiliate, but also a couple of ClearBridge funds did also very well on that.

And the momentum continues to be -- we -- on ETFs, we had a great quarter, 75% of the quarter was on active ETFs. So it's continued to actually show that, that's where the industry is going, and we have a very ambitious plan to continue that growth.

Our next question is from the line of Bill Katz with TD Cowen.

Just a couple of cleanups for me. One, can you just remind us of what the variable expense is against net asset value or how to think about the incremental margin on market action. #2, maybe just on the WAMCO side, I haven't asked about this in a while, but it seems like volumes there are stabilizing. How are conversations progressing with the investment community given that some but not all the overhang with the regulatory investigation is sort of winding down?

And then finally, I was wondering if you could talk a little bit about broadly, you mentioned that Lexington was not in this most recent quarter. How do we think about maybe the pace of opportunity in Lexington and maybe broadly where you see the big opportunities for growth in fiscal '26?

Great. So I'll take the Western and alts, and then I'll turn it back to Matt on the variable expense there. So just one on Western. I mean, it helped a lot. Obviously, the DOJ came out and said that they're not going to pursue criminal charges, and it will be resolved through a disposition and acknowledged, I think this was also important that the additional time needed was not due to Western. So I think that gave clients a little bit of a breather of an uncertainty.

And you have the benefit -- the investment team is incredibly stable. They have very, very good performance. We've been integrating the corporate functions. We've been integrating institutional sales and the client service that's going very well. And so I think that with clients that has essentially calmed them a bit. I mean we did -- while they're still in outflows, they did have -- I think it was $6.6 billion in gross sales in the last quarter. So there's obviously clients that are still allocating to Western.

With respect to alts, as Matt said, so we had a very strong quarter. Our target for the year is 25% to 30%. We're going to -- it's still early, so we're going to maintain that target. But obviously, at $9.5 billion coming into the private markets, and that is across all private credit secondaries, real estate and venture. So it's nice and diverse. A little over half of it is in the private credit area. None of it was Lexington's Flagship Fund XI. Lexington did have -- it was a combination of its co-invest, FLEX middle market.

There were over 33 vehicles that had inflows in our private markets this quarter. So it tells you it's really broadly distributed, which for us is exciting. Lex Flagship Fund X, they're active -- or XI, they're actively fundraising in the market right now. Their target is to be about where they were on their last fund. They would expect to first close this year, but it will depend. Secondaries continue to be just a great space to be. Last year was a record number in secondaries transactions.

Lexington is considered one of the trusted and long-term partners with experience, and they're not affiliated to any single PE firm. So that also gives them an advantage. So they're having very good strong conversations, but we're pleased to see the extent of inflows and growth even without the Lexington flagship fund. So Matt, and I'll turn it over to you to get to the last part of that.

Sure. Thanks, Jenny. So Bill, on the variable question, about between 35% and 40% of our expenses are variable. And I'm sorry, I didn't address the -- I remembered you asked this question at the end of your previous question where you said if the market goes down, do we have flexibility in our expense base? The answer is yes. We always have variability in our expense base in the event the market goes down.

So that's the answer to that. And then to answer another expense question that Patrick had, Patrick, just to make sure I fully answer your question. As it relates to the geography of performance fee-related compensation, first of all, we would always guide to apply 55% to the number of performance fee overall. So 55% is the correct application, whether it's in our compensation line or the G&A line.

And we do, as I mentioned in the answer to the question initially, we expect that number to be quite low in the G&A segment. The G&A segment is just literally for former employees that -- where we have -- where we're paying a portion of the compensation out that they own. But that's de minimis at this point. It was just larger that one quarter. I think it was $24 million to be specific last quarter, and that was because it was a large older fund that had a number of folks that are no longer -- they retired from the company that had interest in the performance fees.

This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's President and CEO, for final comments.

Great. Well, I'd like to thank everybody for participating in today's call. And more importantly, once again, we'd like to thank our employees for their hard work and dedication to delivering this strong quarter. And we look forward to speaking with all of you again next quarter. Thanks, everybody.

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

Welcome to Franklin Resources Earnings Conference Call for the Quarter and Fiscal Year ended September 30, 2025. Hello. My name is Sachi, and I will be your call operator today. As a reminder, this conference is being recorded. [Operator Instructions] I would now like to turn the conference over to your host, Selene Oh, Head of Investor Relations for Franklin Resources. You may begin.

Good morning and thank you for joining us today to discuss our quarterly and fiscal year results. Please note that the financial results to be presented in this commentary are preliminary. Statements made on this conference call regarding Franklin Resources, Inc., which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve a number of known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from any future results expressed or implied by such forward-looking statements. These and other risks, uncertainties and other important factors are described in more detail in Franklin's recent filings with the Securities and Exchange Commission, including in the Risk Factors and the MD&A sections of Franklin's most recent Form 10-K and 10-Q filings. With that, I'll turn the call over to Jenny Johnson, Chief Executive Officer.

Thank you, Selene. Welcome, everyone, and thank you for joining us to discuss Franklin Templeton's Fourth Quarter and Fiscal Year 2025 results. I'm here with Matt Nicholls, our Co-President and CFO. Joining us is Adam Spector. This is Adam's final quarterly call as he has transitioned to a new role as CEO of Fiduciary Trust International. Adam has played a vital role in our success with clients over the past 5 years, and his expertise and leadership will be invaluable to Fiduciary. I'd like to also welcome Daniel Gamba to our earnings call for the first time.

Daniel joined Franklin Templeton in mid-October as Chief Commercial Officer and also assumes the role of Co-President alongside Matt and Terrence Murphy, Head of Public Market Investments. A respected industry leader, Daniel brings extensive experience across public and private markets globally. On today's call, as outlined in our investor presentation, I'll share the progress we made in year 1 of our 5-year plan, which was marked by strong momentum and tangible results. I'll also touch on highlights from our fourth quarter and fiscal 2025.

After that, Matt will review our financial results and quarterly guidance, then we'll be happy to answer your questions. In recent years, Franklin Templeton has continued to build on our strong foundation, advancing our mission to help clients achieve the most important milestones of their lives. As one of the world's most comprehensive asset managers, we combine deep expertise across public and private markets with a client reach spanning over 150 countries. Today, clients look to Franklin Templeton as their trusted partner for what's ahead, one firm offering the reach and resilience of a global platform together with the distinct expertise of our specialist investment teams.

As more asset owners seek multifaceted partnerships with fewer firms that can deliver across asset classes, styles and regions, we believe our business is poised to meet that demand. In recognition, just last week, Money Management in Barron's named Franklin Templeton as its 2025 Asset Manager of the Year in the $500 billion plus AUM category. The award recognizes firms leading through innovation and excellence in investment advisory solutions. Our position today reflects years of deliberate strategic planning and the strength of a global brand that's earned the trust of investors around the world.

This year was another important step forward as we continue to deepen client partnerships, broaden our investment capabilities and strengthen our diversified model. Fiscal 2025 marked the first year of our 5-year plan, and we've made great strides across a number of key focus areas for the company. We are ahead of our plan for alternatives, ETFs and Canvas and on track in the other areas. Let's now turn to the investor presentation beginning on Slide 8 to review our progress report. Starting with Investment Management, we continue to offer a broad spectrum of investment capabilities across public and private assets, helping clients achieve a wide range of financial goals.

In public markets, focus remained on strengthening investment performance while optimizing our product lineup. Performance continues to improve with over 50% of our mutual funds, ETFs and composites outperforming peers and benchmarks across all standard time periods. This underscores our disciplined investment process and commitment to delivering consistent results for clients. This year, we also simplified our investment management structure to strengthen talent development and enhance the way we manage investments across public markets.

These changes are fostering greater collaboration and alignment across teams, positioning us to operate with greater agility and scale. At the same time, we refined our investment offerings to focus on scalable, high-demand strategies where we can deliver the greatest value for clients. That involved thoughtfully retiring certain brands and integrating investment capabilities where it makes sense, steps that make our platform more efficient, scalable and strategically positioned for future growth. Turning to private markets. Franklin Templeton is a leading manager of alternative assets with $270 billion in alternative AUM with the closing of Apera.

We have a broad range of strategies, including alternative credit, secondary private equity, real estate, hedge funds and venture capital. On October 1, we further strengthened our private debt platform through the acquisition of Apera Asset Management, bringing our private credit AUM to $95 billion and enhancing our reach across European markets. The acquisition complements Benefit Street Partners and Alcentra and expands our direct lending capabilities across Europe's growing lower middle market. This year, we fundraised $22.9 billion in private markets, keeping us ahead of pace toward our 5-year $100 billion fundraising goal.

The strong momentum reflects both the depth of our alternative's platform and the growing demand for diversified outcome-oriented solutions. In fiscal 2026, we anticipate an increase to private market fundraising to between $25 billion and $30 billion. We remain committed to the democratization of private assets, bringing institutional quality opportunities to a broader range of investors. Franklin Templeton Private Markets, our wealth management offering, continues to gain traction, contributing more than 20% of our private market fundraising this year, underscoring the strength of our global distribution partnerships and client reach.

We expect this to grow to between 25% to 30% in the next few years. Our perpetual secondary private equity funds, the Franklin Lexington Private Markets Funds have raised $2.7 billion since their launch in January. In addition, our 2 other primary alternative managers, Benefit Street Partners and Clarion Partners, each have perpetual funds with scale. These are semi-liquid perpetual vehicles open to ongoing subscriptions, giving investors efficient access to long-term private market exposure.

This year, we announced an infrastructure partnership with 3 leading firms, Actis, DigitalBridge and Copenhagen Infrastructure Partners, expanding our expertise in one of the most dynamic areas of private investing. Infrastructure is a significant opportunity with an estimated $94 trillion in global funding need by 2040. We're excited to develop a diversified perpetual infrastructure solution for the wealth channel, investing across all subsectors and positioning Franklin Templeton to capture opportunities in this fast-growing market. In addition, we are in the process of launching new products to bring to market. Industry tailwinds for private markets remain strong.

According to Boston Consulting Group, alternatives are projected to represent roughly half of industry revenues by 2029, driven largely by the democratization of alternatives. Goldman Sachs projects the retail alternatives market alone will expand from $1 trillion to $5 trillion over that same period. Franklin Templeton is well positioned to capture our share of this growth leveraging our scale, partnerships and innovation to lead in the next era of alternative investing. Alternatives and retirement represent one of the most exciting opportunities ahead.

This year, we announced a partnership with Empower, one of the largest U.S. retirement service providers with over $1.8 trillion in assets under administration. Together, we're paving the way for private market investments to be included in defined contribution plans, an important step toward broadening access for millions of retirement savers. While still early days, the long-term opportunity is significant. In U.S. defined contribution plans alone, allocations to alternatives are projected to create a $3 trillion addressable market over the next decade.

With $125 billion in defined contribution assets and $440 billion in total retirement assets and a compelling range of alternative strategies, Franklin Templeton is well positioned as demand continues to accelerate. Turning now to distribution. As one of the most comprehensive global investment managers with clients in over 150 countries, we offer our clients a full range of investment strategies in vehicles of their choice. We saw growth across vehicles, driven by record positive net flows in retail SMAs, ETFs and Canvas, contributing to AUM growth from the prior year of 13%, 56% and 71%, respectively.

We are a leader in retail SMAs with AUM of $165 billion across more than 200 high-quality strategies. Our SMA business has grown at a 21% compound annual rate since 2023, reflecting the growing demand for personalized investment solutions. As the market continues to evolve, retail SMAs now about $4 trillion are expected to double by 2030 according to Cerulli. Against that backdrop, we're positioned to capture this growth supported by powerful trends driving investor behavior, greater customization, direct ownership and tax efficiency.

Within the retail SMA segment, custom and direct indexing continue to be the fastest-growing areas. According to Cerulli, direct indexing assets have reached $1 trillion, growing more than 35% from the prior year. We're seeing that strong momentum in our own business. AUM on our Canvas platform has more than tripled since 2023, an 82% compound annual growth rate. Our partnership network is expanding quickly, growing from 67 partner firms in 2023 to more than 150 today. And over that time, our financial adviser base has increased fivefold from just over 200 to more than 1,100 advisers now using Canvas to deliver customized portfolios at scale.

We're exceeding our growth goals driven by continued adoption of personalized investing and the expanding reach of our Canvas platform. Our ETF business also continues to scale rapidly and ahead of plan, driven by strong global demand across fundamental active, systematic active and thematic country strategies. Active ETFs are now mainstream, representing about 10% of industry AUM, yet capturing 37% of flows and probably nearing 25% of revenues in the first half of 2025 according to McKinsey. At Franklin Templeton, our ETF AUM has grown at a 75% compound annual rate since 2023, with 16 consecutive quarters of net inflows and 14 ETFs now exceeding $1 billion in AUM.

Importantly, active ETFs account for 42% of our ETF assets, but more than 50% of flows in fiscal 2025, underscoring the strength of our active ETF positioning, and we're just getting started. In our first year with approximately $50 billion in ETF AUM, we're already halfway to achieving our 5-year goal, a clear sign of the strength, momentum and scalability of our platform. Franklin Templeton Investment Solutions is another key driver of our growth strategy, leveraging our capabilities across public and private asset classes to deliver customized solutions for clients. Investment Solutions AUM grew 11% to $98 billion, in line with industry growth, supported by a strong pipeline.

In July, we welcomed Rich Nuzum, former Executive Director of Investments at Mercer, to lead the expansion of our OCIO business, a major priority for us as asset owners increasingly seek strategic advice on objectives, governance and strategic asset allocation. With Rich's leadership and the strength of our investment platform, we are optimistic about this growing opportunity. This year, our focus on strategic partnerships delivered strong results, including $15.7 billion in multiple insurance sub-advisory fundings, a reflection of our growing position as a trusted partner to leading insurance companies.

Beyond insurance, we also expanded multibillion-dollar relationships with clients in each of our regions. For example, the company was appointed trustee and manager of the $1.68 billion National Investment Fund of the Republic of Uzbekistan, further extending our strong track record in managing strategic investment mandates across emerging markets. These achievements reflect the strength of our partnerships and the trust we've built globally. In this context, we were delighted that the Central Banking named Franklin Templeton its 2025 Asset Manager of the Year, highlighting our expertise and enduring relationships with central banks around the world.

Turning to Slide 9. Two additional important growth areas are private wealth management and digital and technology. Fiduciary Trust International, our Private Wealth Management business is positioned to benefit from major demographic trends, including the $84 trillion intergenerational wealth transfer expected through 2045. As a fully integrated wealth platform offering investment advisory, trust and state, tax and custody services, fiduciary continues to stand out with a client retention rate of about 98%. Global financial wealth is projected to grow at a 6% CAGR through 2029 according to the Boston Consulting Group.

Non-depository trust companies like Fiduciary Trust International have historically grown at a faster rate. In fiscal year 2025, Fiduciary's AUM stood at $43 billion, supported by a strong pipeline of new business. As mentioned earlier, we also strengthened Fiduciary's leadership team with the appointment of Adam Spector as CEO of Fiduciary. Adam has been instrumental in the success of Franklin Templeton's global advisory services and his leadership will help accelerate Fiduciary's next phase of growth.

Fiduciary is a leading independent wealth management business, and we will continue to invest both organically and through targeted acquisitions to position the business for sustained long-term growth. Our goal is to double Fiduciary's AUM by 2029. Turning to innovation. The pace of change in our industry continues to accelerate and Franklin Templeton is leading the way. According to Boston Consulting Group, the market for tokenized real-world assets is projected to grow from about $600 billion today to nearly $19 trillion by 2033, a transformative opportunity that we were early to recognize in the development of our digital assets group.

Fiscal year 2025 was a defining year for our digital asset business. We expanded our product lineup, and our tokenized and digital AUM now stands at $1.7 billion, up 75% from the beginning of the year. As the only global asset manager offering digitally native on-chain mutual fund tokenization, we introduced first-of-the-kind features for registered money market funds using our proprietary blockchain-based tokenization and transfer agent platform, including intraday yield calculation and daily yield payouts, 365 days a year.

During the year, we also completed launching new tokenized funds in UCITS, VCC and private fund wrapper to supplement our 40 Act offering, supporting a broader range of tokenized fund types across multiple jurisdictions and building a strong foundation for the next wave of innovation. And we deepened our global partnerships, embedded our tokenized money market funds into the crypto collateral process and partnering with Binance, the world's largest crypto exchange to develop new products for its global wallet platform. Today, Franklin Templeton stands as the only global asset manager delivering native on-chain mutual fund tokenization.

We remain focused on investing in innovation and technology to harness blockchain's potential, redefining how investors access opportunities and shaping the future of asset management. Over the past year, we've taken a major step forward in our AI journey. What began as hundreds of isolated use cases has evolved into a large-scale end-to-end transformation across 4 core areas: investment management, operations, sales and marketing. This shift is accelerating our scale in agentic AI.

Through strategic partnerships, including our collaboration with Microsoft announced last summer, we're building integrated scalable AI platforms that are already driving measurable results tied to clear business outcomes and commercial impact. As these initiatives deliver results, greater value will be unlocked across the firm. And importantly, I'm pleased to see that AI adoption continues to grow across our workforce. Today, the majority of employees are using approved AI tools to drive productivity, efficiency and better outcomes for our clients.

We continue to advance our efforts in capital management, operational integration and expense discipline, strengthening the foundation for future growth. Matt will cover our progress and next steps in these areas in just a moment. Fiscal 2025 was a pivotal first year of our 5-year plan, one that set a strong foundation for growth, innovation and scale. We executed on our long-term priorities, delivering growth across both public and private markets as clients increasingly look to Franklin Templeton as a trusted partner for comprehensive investment solutions. With that strong foundation in place, we're entering fiscal 2026 with clear momentum and excitement about the opportunities ahead.

Now turning to market performance. Fiscal 2025 brought strong public equity gains despite a complex geopolitical and macro backdrop. After a long period of narrow mega cap leadership, market breadth returned, a welcome shift for active managers. Equities rose across regions, supported by easing monetary policy, steady growth and improved earnings. While markets briefly wavered early in the year amid China's DeepSeek AI debut and U.S. tariff proposals, they rebounded quickly with the S&P 500 and MSCI Emerging Markets both up over 30% from April lows. AI remains a key driver of market direction, fueling innovation and differentiation across industries.

In fixed income, returns were positive even amid policy uncertainty, a government shutdown and shifting rate expectations. The Fed's 50 basis point rate cuts in September and October helped support growth, while inflation has held near 3%, yields remain attractive, though volatility is likely to persist. Our overall view of private markets remains constructive. Activity has been more selective, but we continue to see opportunities. Secondaries offer compelling risk-adjusted profiles and in private credit, areas such as asset-based finance and commercial real estate debt are benefiting from reduced bank lending.

Real estate capital markets remain muted overall, but industrial, multifamily and self-storage sectors are leading performance due to strong and sustainable long-term fundamentals. This is an environment that rewards selectivity, discipline and active management. Market breadth, dispersion and dislocation are creating opportunities across public and private markets where active managers can add meaningful value for clients. These market dynamics set the stage for another strong year at Franklin Templeton. Let's now move to fourth quarter and fiscal 2025 results, beginning on Slide 15.

In terms of investment performance, as mentioned earlier, over half of our mutual fund ETF AUM outperformed peers and over half of composite AUM outperformed their benchmarks in all periods. Turning to flows on Page 17. Long-term flows increased 7.8% to $343.9 billion from the prior year. Excluding Western Asset Management, we had $44.5 billion in long-term net inflows, marking our eighth consecutive quarter of positive flows, excluding Western and reflecting client demand in key strategic areas. Our institutional pipeline of won but unfunded mandates remain healthy at $20.4 billion following record fundings in the quarter.

The pipeline remains diversified by asset class and across our specialist investment managers. Internationally, Franklin Templeton manages nearly $500 billion in assets. And excluding Western Asset Management, we achieved $10.7 billion in positive long-term net flows in markets outside the U.S. That momentum highlights the strength of our global platform and the diversity of our growth across vehicles, regions and client segments. From an asset class perspective, turning to Slide 18. Equity net outflows improved to approximately $400 million for fiscal year 2025.

We saw positive net flows into large-cap value, smart beta, infrastructure, equity income, custom solutions and mid-cap growth strategies. Fixed income net outflows were $122.7 billion. Franklin Templeton Fixed Income more than doubled net inflows from the prior year. With approximately $240 billion in AUM, Franklin Templeton Fixed Income has expertise in every sector and is active in all corners of the global bond market. Excluding Western, fixed income net inflows were $17.3 billion for the year. We experienced positive net flows into Munis and Stable Value strategies. Excluding Western, fixed income generated positive net flows for 7 consecutive quarters.

Let's move to Slide 19. Finally, as I mentioned before, broad-based client demand drove sustained organic growth in alternatives and multi-asset, which together generated $25.7 billion in net flows for the year. This week, we reported preliminary October AUM and flows. Western's long-term net outflows were $4 billion for the month of October and had ending AUM of $231 billion. Excluding Western, long-term net inflows continue to be positive and were $2 billion. We continue to see positive net flows in alternatives, ETFs, Canvas and digital assets. The past year has presented significant challenges for Western Asset, and we remain committed to supporting them.

As part of that commitment, we integrated select corporate functions to drive efficiency and give access to broader resources. Western's client service team joined Franklin Templeton in order to better serve the needs of our clients. These enhancements have been seamless for clients. Western's leading investment team continues its investment autonomy and performance has rebounded strongly with 92%, 98%, 88% and 99% of Western's composite AUM outperforming the benchmark for the 1-, 3-, 5- and 10-year periods.

To wrap up, we take great pride in the efforts we've made over the past year to further grow and diversify our business. As we enter fiscal year 2026, Franklin Templeton stands stronger than ever, anchored by broad investment expertise, global scale and reach and commitment to innovation. We have strengthened our competitive position across public and private markets, expanded our partnerships globally and continued to innovate in technology, AI and digital assets.

These achievements reflect not only our ability to navigate dynamic markets, but also our long-term focus on creating sustainable value for our clients and shareholders. Before I close, I want to thank our employees around the world for all their efforts this past year. Their dedication, expertise and unwavering focus on our clients are the foundation of everything we accomplish. Now I'd like to turn the call over to our Co-President, CFO and COO, Matt Nicholls, who will review our financial results and quarterly guidance. Matt?

Thank you, Jenny. I will briefly cover our fiscal fourth quarter and full year 2025 results, followed by fiscal first quarter 2026 guidance. So for the fiscal fourth quarter, ending AUM reached $1.66 trillion, reflecting an increase of 3.1% from the prior quarter, and average AUM was $1.63 trillion, a 4.4% increase from the prior quarter. Adjusted operating revenues increased by 13.9% to $1.82 billion from the prior quarter due to elevated performance fees and higher average AUM. Adjusted performance fees were $177.9 million compared to $58.5 million in the prior quarter.

This quarter's adjusted effective fee rate, which excludes performance fees, stayed flat at 37.5 basis points compared to the same rate in the prior quarter. Our adjusted operating expenses were $1.34 billion, an increase of 10.5% from the prior quarter, primarily due to higher incentive compensation on higher revenues, higher performance fee incentive compensation and performance fee-related third-party expenses, higher professional fees, partially offset by higher realization of cost savings. As a result, adjusted operating income increased 25% from the prior quarter to $472.4 million, and adjusted operating margin increased to 26% from 23.7%.

Fourth quarter adjusted net income and adjusted diluted earnings per share increased by 35.7% and 36.7% from the prior quarter to $357.5 million and $0.67, respectively, primarily due to higher adjusted operating income and adjusted other income and a lower tax rate. As of September 30, we impaired an indefinite-lived tangible (sic) [ intangible ] asset related to certain mutual fund contracts managed by Western Asset and recognized a $200 million noncash charge in our GAAP results. Turning to fiscal year 2025, ending AUM was $1.66 trillion, reflecting a decrease of 1% from the prior year, while average AUM increased 2.6% to $1.61 trillion.

Adjusted operating revenues of $6.7 billion increased by 2.1% from the prior year, primarily due to an additional quarter of Putnam, higher average AUM and elevated performance fees, partially offset by the impact of Western outflows. Adjusted performance fees of $364.6 million increased from $293.4 million in the prior year. The adjusted effective fee rate, which excludes performance fees, was 37.5 basis points compared to 38.3 basis points in the prior year.

The decline is primarily driven by strong growth into lower fee categories such as ETFs, Canvas and multi-asset solutions, mitigated by lower fee Western outflows and increasing flows into higher fee alternative asset strategies. Our adjusted operating expenses were $5.06 billion, an increase of 4.3% from the prior year, primarily due to an additional quarter of Putnam, higher incentive compensation on higher revenues and sales and higher spend on strategic initiatives, partially offset by the realization of cost-saving initiatives.

Importantly, as previously guided, adjusted for an additional quarter of Putnam and excluding incentive fee compensation, our fiscal year expenses were substantially similar to fiscal year 2024, less than 1% difference. This led to fiscal year adjusted operating income of $1.64 billion, a decrease of 4.3% from the prior year. Adjusted operating margin was 24.5% compared to 26.1% in the prior year, reflecting our support of Western. Compared to prior year, fiscal year adjusted net income declined by 6.3% to $1.2 billion, and adjusted diluted earnings per share was $2.22, a decline of 7.5%.

The decreases were primarily due to lower adjusted operating income and lower adjusted other income. On other topics, we continue to focus on capital management and operational integration to drive efficiency and long-term value. As stated on Slide 9 in the investor presentation, from a capital management perspective, we returned $930 million to shareholders through dividends and share repurchases, funded the majority of the remaining acquisition-related payments and repaid $400 million senior notes due March 2025 in the current year.

Our dividend, which has increased every year since 1981, has grown at a compound annual growth rate of approximately 4%. Our balance sheet provides flexibility to invest in the business organically and inorganically. We have co-investments and seed capital of $2.8 billion, an increase from $2.4 billion from prior year to develop and scale new investment strategies. In addition, while continuing to invest in long-term growth initiatives, we also continue to strengthen the foundation of our business through disciplined expense management and operational efficiencies, especially given the ongoing evolution of our industry.

Our plan to further simplify our firm-wide operations, including the unification of our investment management technology on a single platform across our public market specialist investment managers remains on track, both from a cost and implementation perspective. We have also integrated functions of certain specialist investment managers to simplify investment operations and increase collaboration across the firm. Before presenting our fiscal first quarter 2026 guidance, I just wanted to reiterate an important point on our fiscal year 2025 expenses.

As mentioned earlier, when adjusting for an additional quarter of Putnam and excluding incentive fee compensation, our fiscal year expenses were substantially similar to fiscal year 2024, less than 1% difference. This is notwithstanding markets being significantly higher in the year and the relatively modest difference is fully attributed to higher sales commissions and higher valuation of mutual fund units linked to deferred compensation. All other investments across the company, including additional resources tied to alternative assets, ETFs, Canvas, multi-asset solutions, investment management technology and operations have been directly funded through savings initiatives.

Turning to fiscal year 2026 first quarter guidance. As a reminder, guidance assumes flat markets and is based on our best estimates as of today. We expect our EFR to remain at mid-37 basis points for the quarter. We anticipate the EFR to be stable as higher growth in lower fee categories are partially offset by higher fee alternative asset flows. In future periods, episodic catch-up fees may move the EFR temporarily higher. We expect compensation and benefits to be approximately $880 million.

This assumes $50 million of performance fees at a 55% payout and also includes approximately $45 million to $50 million of annual accelerated deferred compensation for retirement-eligible employees, flat from the first quarter of 2025. For IS&T, we're guiding to $155 million, consistent with the prior quarter. We also expect occupancy to be flat at approximately $70 million. G&A expense is expected to return to previous guide levels in the $190 million to $195 million range and includes elevated professional fees.

In terms of our tax rate, we expect fiscal 2026 to be in the range of 26% to 28% due to a high proportion of U.S. income and the effect of increased tax rates globally. We're 1 month into the 2026 fiscal year, and it's obviously early, but consistent with our plans discussed earlier in fiscal 2025, we begin the year knowing that we have approximately $200 million of gross expense efficiencies for fiscal 2026, but the net amount of those efficiencies will ultimately depend on market and our performance during the year, both of which are up to start with as we go into the new fiscal year.

Similar to fiscal 2025, these savings will also fund ongoing investments across the business, absorb increased fundraising expenses and $30 million of expenses added from the Apera acquisition. However, all else remaining equal from this point, we expect to end fiscal 2026 at or below adjusted expenses versus fiscal 2025 and at a higher operating margin. And now we would like to open the call for questions. Operator?

[Operator Instructions] The first question is from Alex Blostein from Goldman Sachs.

Thanks for all the detail and some of the updated targets as you think about some of the growth areas for the firm. Super helpful. I wanted to start with a question around alts. When you talk about the fundraising target for 20 -- fiscal 2026, I think you said 25 to 30. Can you just unpack how much you assume for Lexington's flagship fund? And then within that, how you're expanding their retail alts lineup as well?

So as you said, we think the 2026 target is between $25 billion and $30 billion. And just, Alex, you remember, last year, we said $13 billion to $20 billion, and we thought the $20 billion would be contingent on the first close of Lexington. That didn't actually happen, and we still blew away that number at, I think, $22.7 billion. So this year, the $25 billion to $30 billion will be a mix of Lexington. There will be contributions from Clarion on the real estate, BSP and Alcentra as well as Venture. Lexington could be half of that, but the others are intended to contribute significantly. And we think 2026 is going to be a real well-routed year as far as all of the alts managers contributing.

Got you. And then, Matt, one for you on expenses. So I heard you kind of try to bridge exiting fiscal 2026 all-in expenses, same or better or lower, I should say, expense run rate. Can you just help us think maybe through the cadence of that over the course of the year or maybe asked another way, your just total expense guide for 2026 in totality?

Yes. As I said in the prepared remarks, we guided earlier on in the year when markets were a lot lower that we'd be targeting $200 million of cost savings for 2026, which will be spread out through the year, and we're confident that we've achieved that. It's now a matter of determining the net amount that we can achieve. And there's a lot going on, as mentioned by Jenny on this call and as I referenced. We're confident that we can self-fund many of these things from the $200 million. We can absorb the increased fundraising that I mentioned when I talked about the $200 million earlier in the year, I caveated that with the increased fundraising that we expect this year and the addition of Apera.

And also, we've mentioned in the past, the absorption of the Aladdin project expenses. So all those things, taking all those into account and beginning the year with the market up 15%, 20%, depending on what market you're talking about, we're still confident that we end the year at least -- I want to say, at least in line with where we were in 2025 with the full expenses, excluding performance fees from both years. And what I mean by at least is there's a very good shot that we are below that amount.

It's very early on, Alex, obviously, for the year. So that's all I can give right now. The second thing I'll say, though, is that we do expect the results as we move into the year, except the first quarter where the margin would be a little bit lower because the accelerated deferred comp probably represents about 2% of margin. But if you take that out every quarter as we model our way through the year, all else remaining equal, we'd expect the margin to tick up. Second, third, fourth quarter, we expect the margin to get increasingly higher towards our target of 30%, as we've also referenced in the past.

[Operator Instructions] The next question is from Ben Budish from Barclays.

Jenny, you talked about your ambitions on the infrastructure side in your prepared remarks. Curious if you can unpack that a little bit more. You mentioned some wealth products coming to market, a number of partnerships. What's sort of in the pipeline for the near term in terms of new funds? And maybe talk a little bit about what your current exposure is today?

So -- sorry, let me just get a clarification. Are you talking infrastructure, meaning like the stuff we're doing on tokenization and blockchain or infrastructure, meaning the alternative products infrastructure?

The latter.

Okay. So we announced like we think that the infrastructure category is just massive. There's -- as we all know, you guys have heard the statistics as far as the number of projects that are needed to be funded out there. And so the relationship that we created, the partnerships with DigitalBridge, which DigitalBridge is known for their sort of data centers, cell towers, fiber networks kind of thing. Copenhagen Infrastructure Partners are really greenfield energy manager and then Actis is sustainable kind of infrastructure. Infrastructure requires massive scale. And so none of these players play particularly -- have really any penetration in the wealth channel.

And so we're able to -- what we're going to do is be able to build a fund around participating in their deals that will then distribute in the wealth channel. Now that doesn't prohibit us from being able to do some M&A if the appropriate opportunity comes. But infrastructure is an asset class that is particularly desired by people who are looking for income because these tend to be long-term PPA products and others that kick off a lot of income. So we felt that we needed that category to fill out our alternative's capability. We didn't find something that was of scale that we wanted to acquire at the time and this -- and they needed to get into the wealth channel, or they had a desire. So it's a good match.

The next question is from Bill Katz from TD Cowen.

I appreciate all the guidance and commentary. Jenny, I'm very interested in what you guys are doing on the AI and the tokenization side. You do seem to be way ahead of most of your peers as our conversations are going. Can you talk a little bit about how you sort of see maybe the opportunity in particular for tokenization, how that might impact the ability to drive performance, what it might mean for operating costs and ultimately, how it might redefine distribution opportunities?

Sure. So again, it's really important to just think about digital assets and tokenization is blockchain, it's just a programming language. It's a programming language that does certain things really efficiently and then it's going to open up new opportunities. So we are the only ones who have -- and we built a transfer agency system and a wallet-based system because they didn't exist in the market. Starting in 2018, we had approved -- I think it was in 2021, the SEC approved our tokenized money market fund. And to give you an idea of the opportunities, because it's significantly cheaper to run and there's -- we're able to offer our money market fund with an initial investment of $20.

Our traditional money market fund is you have to have $500. And the second thing that technology enables us to do is we can -- with this money market fund, we actually calculate the yield every second, and we pay it in your account every day, 365 days a year. So this is important for people who are, say, a hedge fund who are wanting to leverage -- use the money market fund for collateral and they only own it for partial part of the day, they can get 4 hours, 32 minutes and 22 seconds worth of yield that is paid in their account even for a partial day ownership. So it's just going to create new capabilities, less expensive new capabilities.

And then on distribution, you saw that we had an announcement with Binance. So Binance is a crypto exchange, 270 million wallets. They're interested in bringing traditional, we're actually talking to a lot of different exchanges. They're interested in bringing additional products to traditional products that are tokenized because we built this capability, and we're the only asset manager that has this capability that I'm aware of, we can take like ETF and other products and tokenize them and list them on some of these exchanges. So it opens up a new distribution capability. But I think the future, all mutual funds, all ETFs, all will be tokenized merely because the technology is tremendously efficient. And so we're excited to be leaders in this space.

The next question is from Brennan Hawken from BMO Capital Markets.

Can we get an update on your expectations for the latest Lexington flagship? Maybe what caused the timing for the first close to slip? What are your updated expectations for size? And do you have any updated expectations for timing for any of the -- either the first or the final close?

The -- so first of all, just to be clear, it was always a stretch if there was a first close. We just felt like it was important to list it as a possibility. I do think that everybody would say that the fundraising environment is more difficult than it's been historically. But again, if you're in the secondary space, there's so much opportunity in the secondary space because the real issue is the clogging of so many of the LPs with private equity that is not moving. Private equity is distributing at about half the cash flow that they've done historically.

And so as these guys are needing liquidity, whether it's because they just need it in their funds or because they want to participate in a new round of private equity, they're turning to firms like Lexington. And size really matters. Scale matters in the secondary space. And so there's only a few firms like Lexington that have that kind of scale that gives them a real advantage to play in the bigger deals. I think their target is -- I'm trying to find my notes; I think it's about $25 billion for this fund. And I think the first close, they expect in the first half of 2026, calendar 2026.

The next question is from Patrick Davitt from Autonomous Research.

Madam, you mentioned elevated distribution fees, and there's reporting this week that Schwab is planning to add a 15% platform fee on all of its third-party ETFs. ETFs obviously a big growth story for you this year. So curious if you can give us an idea of how much of your ETF growth has come from Schwab, if at all? And then more broadly, any thoughts on to what extent you're seeing a more pervasive push from all of your distribution partners to increase revenue shares like this?

Well, that is not a dynamic that has changed. It's probably just changed as ETFs have taken off. They're trying to -- more of them are trying to push for that. But as you know, that is something that we always deal with in this business, who's actually responsible for the distribution? Is it the platform? Is it the individual? And so there's probably capability in the active ETFs to be able to do some amount of that. There are already players that have it.

We have not been particularly big on the ETF portion with Schwab. So it probably impacts us less immediately. But obviously, as we desire to grow there, it will be something that we will have to work with. I think that it's going to be difficult on these platform fees on passive ETFs because they're obviously cheaply priced. But as the world is moving to more active ETFs, 43% of our ETFs are in the active space above the industry. We'll have to deal with those kind of revenue share type programs.

And Patrick, just to tie your question back to that, I think you were tying it also to the G&A remark that I made on increased placement fees. That's really to do with alternative asset placement fees, not the ETFs and mutual fund type fees that you're referring to. So when I talked about G&A-related expense item around distribution, I meant placement fees related to alternative assets.

Next question is from Craig Siegenthaler from Bank of America.

My question is on your tax efficient suite. You have a pretty big offering here, and you're seeing good flows across munis, especially the SMA wrapper and also in Canvas with direct indexing. Do you think flows here could get even better given rising adoption and allocations among high net worth investors? And I don't think you have anything in the hedge fund space where you can generate even more tax alpha and flows there just started taking off this year. Is that a gap that you can fill in at some point?

We have a product called MOST. It's an options overlay product. So actually, we do have capabilities in that space. It's just now really starting to get traction. Look, we think that the direct indexing and the overlay space is going to just continue to grow. a lot of reason is the dynamics of fee-based advisory where they prefer that, and they can show the client that they've had tax efficiency.

So we do have that capability with an acquisition we did, and we're really just growing it on the -- we continue to add more and more platforms. I think we have 175 sponsors now that we're now selling our SMAs to. Canvas continues to add more and more platforms every month. And once you get on a platform, the flows just continue to come on. And -- I don't know, Adam, you want to add anything else to that?

Yes. I would only say that a real power comes from being able to combine these different capabilities. So we're growing well in munis. We're growing well in ETFs, Canvas as well as 1/30/30 and option-based strategy. So to be able to do them all through a Canvas platform, which we're building towards is where the real power is. And I think we're one of the few firms that can offer all of those things in the combined suite.

The next question is from Brian Bedell from Deutsche Bank.

Thanks for all the great today on the outlook. Maybe my question is on the credit alternative business and the direct lending strategy, 2-part question. One is just on your views on credit quality in direct lending. If you can comment on whether you have any exposure to any of the problem, credits that have been out there and maybe just a view on whether you think that's -- do you think these are idiosyncratic? And then on the growth side of that, it sounds like you're increasing your traction in Europe with the most recent Apera acquisition, bolted on with Alcentra. So maybe your view on expanding direct lending and growth of this business in Europe over time? Is that an additional growth lever for you?

Yes. So first on kind of the opportunity in private, we're not seeing a deterioration in credit. And we tend to -- our view on the economy is that its still very strong, consumer is strong and you're just not -- while you'll hear about the banks talking about a slight uptick in subprime, it's really coming back to kind of more normal levels. As you could see, the fixed income market is really priced for perfection. Nobody is expecting great deterioration. We had very, very teeny exposure at ESP to one of those 2. And the truth is that was really looking like fraud. So it's not something that's systemic from a credit standpoint.

So we still remain very optimistic in the credit market, again, especially because of the strength of the economy, which we still think is very strong. And then, yes, we're excited about direct lending. We think you -- if you're in the private credit space, the ability to move between different types of credit is important because sometimes something gets squeezed and it's trading very tightly, and you want to be able to pivot. But the Apera acquisition brought direct lending capabilities, particularly in the lower middle market, which is -- it's not a particularly crowded space there. So we're very optimistic about it, and we think it rounds out the private credit capabilities that we have.

The next question is from Dan Fannon from Jefferies.

Matt, I wanted to follow up on your comments around the fee rate and the outlook for next quarter as well as the year, given continued growth within alternatives, obviously, beta has been quite strong, and you've had declining fixed income. So trying to understand the mix a little bit better. And I believe there is a fund that's going to start kicking in from Lexington for fees starting, I believe, October 1. So curious as to why you're not seeing a bit more of a step-up in that fee rate sequentially.

Yes. I think when you factor in a Lexington fundraise over the year, as I mentioned in my prepared remarks, we will see an increase or we are very likely to see an increase in the EFR to -- into the higher 37s, 38s, even something like this. But I'm trying to make sure we communicate that, we expect that to be a temporary increase and then for it to come back down to reflect the very strong growth we have in ETFs, Canvas, multi-asset solutions. And remembering as well, Putnam has been very, very strong in terms of flows and Putnam's effective fee rate is 34 basis points in average across the franchise. That's getting offset.

Those lower fees are getting offset by a steady and becoming more predictable alternative asset set of strategies and flows at much higher EFRs. So that positions the company to have a very stable EFR with upside as and when we raise larger flagship funds, so that's the way I would sort of describe it. Stable EFR with upside during different periods based on flagship fundraisings. And the reason why we're stable is because you've got the offset of the higher fee, more predictable alternative asset raises away from the flagship funds combined with strong, larger flows on average into the lower fee categories of ETFs, campus and multi-asset solutions.

The next question is from Ken Worthington from JPMorgan Chase & Company.

A little one for me. Shareholder servicing fees really jumped sequentially, about a $20 million pop. So anything unusual here? Or is it just sort of some mix changes, maybe some seasonality? It just seems like the jump is much bigger than we typically see in the fiscal fourth quarter.

Matt, do you want to take that?

Yes, that's to do with our -- it's a little bit seasonal, but also to do with the arrangements we have with our outsourcing providers around the TA. So you'll see that normalize.

Yes, higher transaction fees. There's also a little bit of trust and estate planning fees in there, but it's seasonal.

The next question is from Michael Cyprys from Morgan Stanley.

I wanted to ask about agentic AI and the Wand AI partnership. I was hoping you could elaborate a bit on the partnership, your goals, ambitions there, why partner with Wand versus other vendors. It sounds like you've been running a pilot program with them for the past year. I was hoping you could speak to some of the learnings from that, how it's informed your approach? And how might you quantify the sort of savings or reduced expense growth over time?

Yes. So we've announced a couple of different partnerships in the AI space, Microsoft, AWS, Writer AI. In each of these cases, I think we've done a good job that has excited the AI providers that we're not just going in and fixing one little thing. We're going in it from a platform approach. And so for example, Microsoft has helped us on distribution, which uses multiple agents and then integrates them. And so what Wand has been working on, for example, is an ESG agent with the Franklin Equity team and our solutions team where it goes out and gets internal data and external data, brings it back and runs it through their kind of a scoring on ESG.

What's interesting with Wand is they really enable us to -- and by the way, these partnerships mean they're co-developing. They're going to provide resources because they want the learnings of what's happening in your environment so they can take the domain knowledge and be able to go, extend it to other people and build their business that way. So they provide us free resources. What's interesting with Wand is we're able to connect these multiple agents in our investment groups.

And then we can actually take those agents and go across other investment teams and be able to customize them to say, just take the ESG example to specifically however that team uses their ESG screen. And just a little bit on Wand. I mean, they are backed by leading AI venture firms. So Thiel Capital, Peter Thiel's Fund, Fusion Fund, [indiscernible]. These are all big AI firms or AI venture capital firms, and they're terrific, and they've been a great partner with us. And like I said, we have multiple partnerships with different AI development companies.

This concludes today's Q&A session. I would now like to hand the call back over to Jenny Johnson, Franklin's Chief Executive Officer, for final comments.

I'd just like to thank everybody for joining us on today's call. And once again, I want to thank our employees for their continued hard work and dedication, and we look forward to speaking with you again next quarter. Thanks, everybody.

Thank you. This concludes today's conference call. You may disconnect.