Prepared remarks
Welcome to the Invesco Second Quarter Earnings Conference Call. All participants will be in a listen-only mode until the question-and-answer session. At that time to ask a question, you may press *1. This call will last one hour. To allow more participants to ask questions, one question and a follow-up can be submitted per participant. As a reminder, today's call is being recorded. Now I will turn the call over to Greg Ketron, Invesco's Head of Investor Relations.
Okay. Thanks, operator, and to everyone joining us today. In addition to the press release, we have provided a presentation that covers the topics we plan to address on the call. The press release and presentation are available on our website, invesco.com. This information can be found by going to the Investor Relations section of the website. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slide 2 as well as the appendix for the appropriate reconciliations to GAAP. Finally, Invesco is not responsible for the accuracy of our earnings transcripts provided by third parties. The only authorized webcasts are located on our website. Andrew Schlossberg, President and Chief Executive Officer, and Allison Dukes, Chief Financial Officer, will present our results this morning, and then we will open up the call for questions. I will now turn the call over to Andrew.
All right. Thanks, Gregory, and good morning to everyone. I am pleased to be speaking with you all today. We have built significant momentum thus far in 2026, as we continue to execute against our strategic priorities. Year-to-date, we posted record net inflows of $67 billion or a 7% annualized organic growth rate and generated record net revenue with an increase of 17% over the same period last year. Our broad product suite and global reach is resonating with clients, as they seek to navigate an ever-more complex market environment. Our increasingly scaled platform and disciplined approach to expense management gives us significant operating leverage. We increased operating income by 35% in the first half of this year and we expanded our operating margin by nearly 470 basis points as compared to the same period last year, reaching 37.5% in the second quarter. Further, we grew our bottom line by nearly 60% in the first half of 2026 as compared to the first half of last year.
This is a testament to the hard work that our colleagues across Invesco have been doing over the past several quarters to streamline our business, drive profitability and margin expansion, and strengthen our balance sheet. As highlighted on slide 3, we are innovating for our clients, clarifying and simplifying our organization and, as a result, we are delivering for our shareholders. Product line management and innovation are key to our growth and are critical in remaining relevant to our clients. As such, we have made several additions and advancements in areas where there is significant demand, like ETFs, SMAs, model portfolios, and private assets. We have launched more than 50 products this year, across the Americas, EMEA and APAC. This includes six new active ETF launches and a new partnership with Superstate, where we are now the manager of our first tokenized treasury strategy. Another way we are innovating for our clients is through partnerships.
Our Barings and LGT Capital private market partnerships are designed to help us accelerate growth in the high-opportunity U.S. private wealth and defined contribution markets. We completed our first product initiatives with Barings at the beginning of this year and we look forward to sharing more details on additional product launches with each firm later this year. We have also established partnerships in India and Canada that have allowed us to redefine our positions in these markets from full ownership to minority status and as a sub-adviser respectively, while aligning with strong local financial institutions. These changes have resulted in greater firm-wide focus, reduced operating expenses, increased leverage of our global investment platform, created balance sheet benefits and enhanced revenue opportunities. To this end, during the second quarter, we successfully completed CI's acquisition of our Canadian products, and we have commenced our long-term strategic partnership with them where we are now sub-advising funds with approximately $9 billion in AUM.
Another clear indicator of the innovation aptitude at Invesco was the successful conversion late last year of the QQQ fund. In the first half of 2026, the QQQ generated an incremental $130 million in net revenues for Invesco, its AUM grew 20% and it produced strong organic net flow growth in the second quarter. We have significant opportunities to continue to expand this flagship competitively advantaged product not only here in the United States, where the traction is incredibly strong, but also in other international markets. The QQQ is now cross-listed on both the Hong Kong and Tokyo Stock Exchanges with over $10 billion of AUM raised in a short period of time. Examples like these are indicators of the strength of the multidecade QQQ brand that is recognized around the world for its innovation. We see several avenues to continue to expand QQQ's client base, our innovation suite in general, and our wider $1.25 trillion ETF complex.
Beyond these and other strategic efforts, we have continued to make progress on our balance sheet recapitalization. We have significantly improved our leverage ratio over the last year from 2.7x to 1.9x inclusive of the outstanding preferred shares. We have also increased our common share buybacks by 80% year to date versus the first six months of last year. Importantly, we have done this while continuing to invest in the business and reduce debt including the outstanding preferred shares. Allison will speak more about these efforts later in the call. We will also update you on our transformational hybrid investment platform implementation which is another strategically important priority that will yield benefits across our organization and for our clients. As we discussed on previous calls, our strategy continues to prioritize opportunities at the intersection of market size and secular change, where Invesco is uniquely positioned to selectively drive growth across regions, channels, and asset classes.
We continue to execute with discipline, allocate capital and resources accordingly and improve performance. So moving on to slide 4, I will discuss how our efforts drove record net long-term inflows in the second quarter. The advantages of our broad increasingly scaled diversified global platform were evident again this quarter. Markets were supportive, driven by strong equity appreciation and improving fixed income returns, resulting in investor capital remaining in motion across the industry, albeit more narrowly focused and mindful of ongoing macroeconomic and policy uncertainty. Clients continue to entrust Invesco with significant new capital across our global product set. Net long-term inflows during the period were a record $45.1 billion marking the 12th straight quarter of net inflows and representing annualized organic growth of nearly 9%. Additionally, we generated $13.2 billion in global liquidity inflows, ending the period with $215 billion in AUM.
Altogether, we reached an AUM high-water mark of $2.5 trillion. Importantly, we continue to be encouraged by the breadth of our overall growth. We had solid positive flows across several dimensions including in many of our strategically important investment capabilities, across each of our three regions and in both our active and passive strategies. The breadth of our inflows was also demonstrated by the fact that over 30 of our products generated more than $500 million in net inflows during the quarter. The Asia Pacific and EMEA regions again produced very strong net inflows, with 10% and nearly 7% annualized organic growth, respectively. Additionally, on a gross sales basis, we had our highest volume quarter for actively managed funds. With all of this as a macro backdrop, I would like to spend a few minutes highlighting growth drivers in each of our investment capabilities. Starting with our ETF and index offering, where we continue to meaningfully scale and diversify our platform to meet evolving client demand.
AUM for these funds stood at a record $753 billion or nearly $1.25 trillion when including the QQQ. We also had a record $30 billion of net inflows during the quarter, with 17% annualized organic growth. Within our ETF range, we garnered net inflows across a diverse set of products, led by our QQQ innovation suite and our quality and momentum equity factor funds, which raised a record $7 billion of net inflows in the second quarter. It is also notable that nearly a third of our net inflows were generated in the EMEA region, where we continue to see strong demand for our ETF range. We remain focused on innovation in the ETF space. During the quarter, we expanded our BulletShares lineup with seven new fund launches in the United States, in addition to launching five ETFs in the EMEA region including two new active funds. We have built a robust ETF platform globally, which continues to grow as demand has accelerated for high-quality differentiated strategies.
We currently manage $25 billion in active ETFs across more than 40 products, and the AUM base increases more than $40 billion when including index strategies that are executed by our active investment teams. Our QQQ fund also attracted strong interest in the second quarter with $14 billion in net inflows or 12% annualized organic growth. This reflects our competitively advantaged position supported by a very large and broad institutional and retail investor base, unmatched liquidity with tight spreads and deep options and derivative markets built over multiple decades for this flagship product. Moving on to fundamental fixed income, demand for our products remained robust. While we report net inflows of a modest $400 million for the quarter on this slide, when you widen the scope to include the fixed income flows from our ETF and China joint venture, it expands our overall asset class net long-term inflows to $14 billion during the quarter, or 11% annualized organic growth.
This growth was broad with inflows from each of our regions from both the retail and institutional channels and across both active and passive products. Two drivers of fundamental fixed income flows were demand for individual SMAs from U.S. wealth management clients and overall institutional fixed income demand in EMEA, where we recorded net inflows of nearly $2 billion for the quarter. Our entire U.S. wealth management SMA platform, which also includes a portion of equity assets, now stands at nearly $40 billion in AUM. We have one of the fastest growing SMA offerings in the market generating an annualized organic growth of 23% this quarter. Moving on to our China joint venture, our growth continues to be underpinned by our scale and the improving macro stability in this market. We reached a record high AUM of $163 billion, a 15% increase over the prior quarter. Net long-term inflows were $6.9 billion, delivering a 22% annualized organic growth rate.
Net inflows were driven by our fixed income and our fixed income-plus strategies, which are a form of balanced funds. To further support growth in our business, we launched 11 new funds this quarter which collectively generated $1.2 billion in net inflows. These funds align with the growing demand for innovation, balanced and equity strategies. We continue to be well positioned as the Chinese asset management market develops and evolves in both the individual investor and retirement sectors. Shifting to private markets, we posted $1.9 billion of net inflows across our alternative credit and direct real estate offerings. In credit, we saw a return to demand for our industry-leading bank loan ETF, BKLN. This growth was also augmented by net inflows into our CLO products. Despite near-term volatility and heightened headline risks, credit fundamentals remain broadly intact and spillover risks into the structured loan space have been limited.
We continue to see strong demand for private credit solutions from institutional investors on a global basis and the current environment has not changed our long-term expansion plans in the retirement and wealth management channels. Our private real estate capabilities also recorded positive net inflows of $1.4 billion or an annualized organic growth rate of 8% this quarter. These results were led by INCREF, which is our real estate debt fund for U.S. wealth management clients, which continues to gain scale and assets. Including leverage, it is now totaling over $6 billion. This fund was launched only a few years ago and it is yet another example of our deep investment talent, product innovation, and strong distribution teams collectively driving growth. We are excited about the prospects across our private markets business. Organic growth opportunities are amplified by our partnerships with Barings and LGT Capital to further penetrate the wealth management and defined contribution market.
Moving on to our multi-asset capability where we had modest net outflows for the quarter. Continued inflows in our systematic equity offerings were offset by outflows from balanced risk allocation strategies which remain out of favor. Finally, in fundamental equities, we continue to have positive net inflows from clients in Asia Pacific, driven by ongoing momentum in our global equity income fund, which remains the top-selling retail active fund in the Japanese market. This fund posted net inflows of $3 billion during the quarter, rapidly growing to $28 billion in AUM while generating a very favorable net revenue yield for Invesco. We also posted our second consecutive quarter of net inflows in our U.S. Value equity strategies. Furthermore, our developed markets fund continues to experience significant moderation of outflows with just $500 million during the quarter. Additionally, on an overall gross sales basis, we are among our best fundamental equity flow quarters since the beginning of 2022, on the heels of an exceptionally strong first quarter.
Despite these positive fundamental equity flow highlights, we remained in net outflows of $7.7 billion overall in this segment. The uptick this quarter included a few large idiosyncratic liquidations from a couple of institutional investors making overall allocation and reallocation positioning decisions. We continue to focus on strengthening our fundamental equity long-term investment quality through talent, risk management and overall platform tool enhancements. We are making progress, and we are seeing improved performance as outlined on the next slide. So moving on to Slide 5, which shows our overall investment performance relative to benchmarks and peers, as well as our performance in key capabilities where information is readily comparable and more meaningful to driving results. Investment performance is integral to winning and maintaining market share regardless of overall market demand.
As such, achieving first quartile investment performance remains a key priority for Invesco. Overall, 44% of our active funds are performing in the top quartile of peers on a three-year time horizon with nearly half reaching that bar on a five-year basis. Further, nearly 70% of our active AUM is beating its respective benchmark on both the three- and five-year basis. We are beginning to see improved performance in our fundamental equities lineup, which now has over 40% of funds performing in the top quartile of peers on a five-year time horizon, with over half beating their benchmark. So with that, I am going to take a pause and turn the call over to Allison to discuss the quarter's financial results, and I look forward to your questions.
Thank you, Andrew, and good morning, everyone. I am going to start with the second quarter financial results that are on Slide 6. Strong organic growth and positive markets drove a significant increase in assets under management during the second quarter. Net long-term asset inflows were a record $45 billion in the second quarter, nearly a 9% annualized organic growth rate marking the 12th consecutive quarter of net inflows. Favorable markets drove a $257 billion increase in AUM, and net flows in the money market funds totaled $17 billion for the quarter. AUM at the end of the quarter reached a record high of $2.5 trillion, a 14% increase over the first quarter, and 23% higher than the second quarter of last year. Average long-term AUM was $2.1 trillion, a 7% increase over last quarter, and 58% greater than last year. Net revenues, adjusted operating income, and adjusted operating margin continued to show meaningful improvement from the first quarter as well as the same quarter last year, while adjusted operating expenses continued to be well managed.
On a sequential quarter basis, net revenue growth was 5%, while adjusted operating expenses were essentially flat, generating nearly 500 basis points of positive operating leverage, and a 300 basis point operating margin improvement in the second quarter, the operating margin expanding to 37.5%. Adjusted operating income increased 14% to nearly $500 million for the quarter, and adjusted diluted earnings per share increased to $0.71 from $0.57 in the first quarter, a 25% improvement. On a year-over-year basis, net revenue growth was over 20% while adjusted operating expenses increased 9%, generating over 10 points of positive operating leverage and a 360 basis point operating margin expansion. Adjusted operating income increased 45%, and adjusted diluted earnings per share nearly doubled from $0.36 last year to $0.71 that we reported for the second quarter. Our focus on strengthening the balance sheet continued during the quarter as we reduced net debt by more than $450 million in the second quarter.
The reduction combined with improved EBITDA resulted in a substantial improvement in our leverage ratios. Finally, we increased common share repurchases in the second quarter as compared to prior quarters, buying back $50 million, or 1.9 million shares. We also announced in April an increase in the quarterly common stock dividend to $0.215 per share. Now moving to Slide 7. Secular shifts in client demand continue to drive strong growth in lower-fee products, such as ETFs, including the QQQ, while the demand for higher-fee products, such as fundamental equity, has not been as strong. This has resulted in a more balanced AUM profile for Invesco, which better positions the firm to navigate various market cycles, events, and evolving client demand. We have seen the impact of the asset mix shift moderate over the past several quarters, resulting in a more modest decline in the net revenue yield and more recently approaching a degree of stabilization.
To provide context, the net revenue yield was 22.4 basis points for the second quarter. While slightly down from the first quarter, it was in line with the fourth quarter. The exit yield at the end of the second quarter was 22 basis points. Turning to Slide 8. Net revenue of $1.3 billion in the second quarter was $224 million higher compared to the same quarter last year, and $65 million higher as compared to last quarter. The increase in net revenue was largely driven by investment management fees, predominantly due to higher average AUM. On a year-over-year basis, the increase was also driven by the reclass of the QQQ to fee earning. Operating expenses increased $70 million versus the same quarter last year, and only $2 million as compared to last quarter. The year-over-year increase was mainly driven by higher employee variable compensation related to the growth in net revenue, and marketing expenses related to the reclassification of QQQ.
The hybrid investment platform implementation costs were $14 million in the second quarter, in line with our expectations and prior quarters. The incremental operating expense associated with AUM that has been moved on to the hybrid platform was $5 million in the quarter. A majority of this expense is impacting property, office and technology, and it will be in this line item going forward. Regarding the hybrid implementation platform cost for the remainder of 2026, we expect quarterly one-time implementation costs to run closer to $15 million per quarter in the second half of this year with the push to have implementation completed by year end. As we transition more AUM onto the platform, incremental expense related to AUM on the platform will build towards $10 million per quarter later this year. Expenses associated with the platform may fluctuate quarter to quarter due to timing. Effective tax rate for the second quarter was 24.9% in line with expectations.
For the third quarter, we estimate our non-GAAP effective tax rate will be in the 25% to 26% range, excluding any discrete items. The actual effective rate can vary due to the impact of nonrecurring items on pretax income and discrete tax items. I am going to wrap up on Slide 9. We continue to make progress on building balance sheet strength and improving our leverage profile. During the second quarter, we reduced total debt $343 million and net debt by over $450 million as compared to the first quarter. This included reducing the amount drawn on the revolving credit facility, from $1.1 billion at the end of the first quarter to $136 million at the end of the second accomplished through operating cash flow. The reduction in debt coupled with improving EBITDA, resulted in a substantial improvement in our leverage ratios. The leverage ratio, inclusive of the preferred stock, declined by 0.4 of a turn in the second quarter to 1.9x.
The leverage ratio excluding the preferred stock declined by over 0.3 of a turn to 0.54x for the second quarter. Looking back over the past year, the leverage ratio inclusive of the preferred stock improved by nearly a turn driven by $1.5 billion in preferred share repurchases, debt reduction, and improving EBITDA. We expect further improvement in the leverage ratios for the remainder of the year as we reduce the amount drawn on the facility and simultaneously grow EBITDA. We also increased the degree of common share repurchases in the second quarter as well as dividends. We increased the amount repurchased to $50 million, or 1.9 million shares and in April, we announced an increase in the quarterly common stock dividend to $0.215 per share. We intend to continue a regular common share repurchase program going forward as we target a total payout ratio, including common dividends and share buybacks, to be near 60%.
To conclude, we generated another quarter of significant organic growth and the diversity of our business, coupled with positive market trends, drove AUM to a near record level. As a result, we delivered strong revenue growth for the quarter. This, combined with well managed expenses, delivered another quarter of positive operating leverage and a significant improvement in our operating margin. Also continued progress on building a stronger balance sheet. We are committed to driving profitable growth, a high level of financial performance, and enhancing the return of capital to our shareholders. And with that, operator, if you could open the line up for Q&A.
Questions and answers
Thank you. An audio question, please press *1. You will be announced prior to asking your question. Please pick up your handset when asking your question. To withdraw your request, you may press *2. One moment please for our first question. Our first question comes from Patrick Davitt with Autonomous Research. Line is open. You may ask your question.
Hey. Good morning, everyone. How are you? I will start with the QQQs. Now that we know kind of what the fee rates are going to be for competitor products, I would like to get your updated thoughts on, firstly, your willingness to adjust the fee for the QQQ and, secondly, to what degree could there be an expense offset to that, either from marketing or custody that you can squeeze to offset any revenue? Thank you.
Yes, Patrick. Thanks for the question. Let me start and then Allison can pick up on some of the specifics of the second part of it. I want to reiterate a couple of things. We have a 25-year history managing the QQQ. It has a very large and entrenched position. It has a ton of brand recognition. It is one of a kind and it is also part of our ETF innovation suite, which now has $650 billion of assets across many products around the world. The QQQ has a ton of scale, a ton of liquidity, and execution benefits. It is the fifth-largest ETF and the second-most actively traded in the world. Investors in our funds spend a lot of time looking at total cost of ownership, and that goes beyond the total expense ratio. That is what investors consider. Shareholders have benefited from that and will continue to benefit given the size and scale, which results in really tight bid-ask spreads, deep on-screen liquidity, a really strong trading base, and $500 billion of notional options associated with it.
So it has a strong ecosystem around it that is unique. Also, switching costs are something people look at, and given the low relative tax basis of so many in the QQQ, those switching costs come with real economic impact. I also want to mention that we have our own test case of how additional products around the QQQ impact things. The QQQM, which we launched about five years ago, stands at about $100 billion today but it did not slow down the QQQ's significant growth during the period either. Over the last three years, that fund is up 2.5 times in terms of its size and it attracted $75 billion of net new flows despite having a lower-priced product alongside it. Recently, as I mentioned in my comments, there is significant ownership of the QQQ around the world, indicative of how quickly we can scale up because of our strong brand. We recently listed in Hong Kong and in Tokyo, and those AUM levels are already at $10 billion combined.
So we are really going to focus on differentiating ourselves on the total cost of ownership, accentuate the deeply rooted QQQ brand which is both recognized in the U.S. and globally, and continue to innovate through the suite's leadership in new markets and new channels. Allison, do you want to pick up on some of the more specific questions?
Sure. Anything pricing related, I would say we are going to focus on long-term client outcomes. We will continue to focus on product differentiation and the ecosystem strength. We are not going to have a short-term competitive reaction. We have been in this for a long time and we are going to be in it for a long time, and we are really focused on total client experience as Andrew was discussing. We have that dominant entrenched position that is worth a substantial amount. All of our marketing spend, as we think about that, is really going to be to continue to focus on promoting the QQQ brand, which arguably is one of the best-known tickers out there. We will continue to focus our marketing dollars on creating education and aiding in advisor adoption. This has been incredibly effective. Hundreds of millions, if not north of $1 billion, has already been invested in that brand over the last several decades.
It will be hard to match that level of brand strength and awareness or even match the spend that we have already spent against it. We have flexibility now to choose where we want to market and direct that spend in the manner that we think is best. A lot of our marketing spend right now is dedicated outside of the United States. As Andrew said earlier, we are north of $10 billion in AUM due to the cross-listing of the QQQ in Japan and in Hong Kong. So we feel very good about the level of marketing spend there. Maybe the last part of your question, I think you mentioned custodian fees and any flexibility there. The custodial relationship is with Bank of New York, which is the custodian. We could not have gotten the conversion done without their help six months ago. Those are long-term contracts that you enter into, so I do not think there is a lot of room there right now, but I want to be clear they have been an unbelievably terrific partner, and we could not have done it without the Bank of New York.
Thank you so much. Very helpful and detailed. One quick follow-up. On the Superstate win: I think that fund was already managed by a firm that is arguably much more established in liquidity management. Could you expand on how that opportunity came together and why you think Invesco was chosen over the previous manager? Thank you.
Yeah. We have a $120 billion global liquidity franchise. You will be managing funds for decades, so we do have a lot of strength and capability in the liquidity side. We have made a commitment to innovate through digital assets and through establishing partnerships, and having the opportunity to take over that $1 billion tokenized U.S. Treasury fund was important to us. I think because of our commitment to innovation, our long-term experience on the global liquidity side, and our vast distribution around the world institutionally and in the retail space, I think that combination made sense for both parties.
Thank you.
Our next question comes from Bill Katz with TD Cowen. Your line is open. You may ask your question.
Great. Thank you very much for taking the questions this morning. Maybe to pick up on the operating leverage, I think it came in well above most people's expectations. Andrew or Allison, I am curious as you think about either the incremental margin or maybe the longer-term margin targets, I was wondering if you could update your thinking for us. And within that, you mentioned in the deck about opportunity to take out some more savings as you migrate down the hybrid platform implementation phase—maybe update us where those savings could come from? Thank you.
Sure. I think we have been quite consistent in saying we had an objective of returning our operating returns back to the high-30s. For a while there, we were focused on getting back to the mid-30s. Now we are squarely focused on continuing to expand into the high-30s and building a more durable operating margin through any cycle. That is the real challenge in a business like ours where you have a high degree of beta and revenue sensitivity to the markets. That has been behind a lot of the work we have been doing for several years now in trying to create the flexibility we need in the expense base and continuing to diversify our revenue sources with a better balanced AUM profile. I think we are really starting to demonstrate some of the benefits of that, so I would say near- to medium-term operating margin targets are to continue to expand and consistently deliver in the high-30s. That is the focus.
As it relates to operating expense guidance relative to the implementation of the hybrid investment platform, our comments are consistent with the guidance we gave at the end of the first quarter. Our focus is on really trying to deliver the implementation by the end of this year. The implementation expenses were $14 million in the second quarter. We are expecting that to be closer to $15 million consistently for the next couple of quarters. Then we also are continuing with the platform fees that we are paying of $5 million that was embedded in the run rate in the second quarter. That should expand to about $10 million per quarter in the back half of this year. Against that, there is a lot of work underneath trying to make sure we are managing our expenses thoughtfully. I think you can see the evidence of that in the second quarter with the really well-maintained expenses. As we get past implementation, we will continue to focus on driving out further operating expenses consistent with our guidance last quarter into 2027.
And Bill, the only thing I would add is the places where we are seeing organic growth—ETFs, SMAs, fixed income at large, cash—these are all categories that scale well. We expect to continue to see growth in those segments.
That is helpful. And this is a follow-up on a different thread. I think about your incremental thought process now on capital return. You have deleveraged pretty significantly. You are generating a lot of free cash flow. I think you mentioned a targeted payout, so combined payout near 60%. Maybe prioritize how you are thinking about capital return. Are you looking to do more deals now? Is the balance sheet in a better spot? Is there opportunity to continue to work with MassMutual to bring down the preferred towards zero? How are you thinking about use of cash flow? That would be helpful. Thank you.
Sure, Bill. I will take that one. I have a fairly consistent approach to capital. Yes, we are continuing to target a 60% payout ratio. We are doing that in an expanding EPS environment. We are continuing to make forward progress by expanding both our buybacks and the modest increase in the common dividend that we announced last quarter. We feel pretty good about the return of capital to shareholders and certainly intend to continue to improve that towards 60%. At the same time, we still have a little bit more to go on the revolver. We noted very substantial progress in the first quarter. We would like to continue to work that down just a bit before trying to address more of the preferred. That is a mutual choice between MassMutual and ourselves and many conditions and circumstances have to align, including their willingness, the rate environment and the premium that is required. Those are negotiated conversations, and we are positioned to do more.
We earlier said we hope to be in a position by later this year or early next year, and I still feel that is probably the right timing. We continue to reserve capacity for investing in ourselves. We are launching new products and we see great investment opportunities in our own product capabilities. We evaluate inorganic opportunities against our own organic growth opportunity, and heretofore we have been able to deliver better shareholder returns on our organic capabilities than anything we've seen from an inorganic perspective. All things are on the table and we are always evaluating the opportunity set.
Organically, we think we have generated close to $200 billion of net long-term inflows over the last two years. We have an ethos of partnership across the company. We have been active in private markets, made changes in India and Canada, and divested from fintechs. We will continue to be creative both organically and inorganically if opportunities present themselves. Thank you very much.
Thanks.
Our next question comes from Glenn Schorr with Evercore. Your line is open. You may ask your question.
Thanks very much. There has been a lot of growth on the tax-aware side of the business. With your brand and distribution network, I would think it would suit very well. Maybe talk about your current capabilities and where you think that market can grow and if you can throw in any thoughts on the recent treasury commentary on a smaller subset of that business. Thanks.
The SMA retail space has grown rapidly industrywide, and we have outpaced that growth. We are up to $40 billion of retail SMA, much of it tax-oriented or tax-aware. A lot of that growth for us has come on the fixed income side, particularly in the municipal space and somewhat longer dated. We have a competitive edge in the fixed income space where others focused more exclusively on equities. We are also seeing growth on the equity side, both in systematic equity and in the fundamental side. As the pivot goes from mutual funds to other formats—active ETFs and actively managed tax-aware SMAs—we think the growth could be considerable. The $40 billion we manage today was roughly half that three or four years ago, so we have had exceptional growth and expect to continue to grow, primarily in the U.S. We will continue to invest in technology to scale this business, which will enable us to expand without a proportional increase in people. We have the investment capabilities in-house to do it.
More specifically, where we saw really strong growth was INCREF, which continues to be one of the fastest ramps in the wealth channel for any of our real estate credit products. It is about $6 billion in AUM and continues to be a strong driver of flows. That demand is not dampened despite rate environment shifts. We do not expect a return to a zero-rate environment like we had five to ten years ago, but the market has been working through that. We continue to see good demand overall. Dry powder for us on the real estate side is around $7 billion, so we still have a lot of unallocated capital. We are seeing a pickup in transaction activity overall and remain modestly optimistic even with the rate outlook.
Next question comes from Daniel Fannon with Jefferies. Your line is open. You may ask your question.
Thanks. Good morning. Andrew, could you expand upon your comments around the QQQ franchise and your outlook for expanding? You mentioned Hong Kong and Tokyo. Are there other regions or initiatives you are looking to do from either a marketing perspective or product launch that should accelerate or pick up as the year progresses?
Yes. There are two big cross-listings out in Asia in the last six to nine months, which are really important markets for us. Those launches amplify the recognition we already have in those markets and provide a double benefit. We have 20 to 25 QQQ-related products across the world, with a majority in Europe, the U.K., and the U.S. We will look selectively not just by geography but also within markets where we have dominance to expand. Given the marketing we have done around the QQQ specifically, we can now be much more expansive across the whole innovation suite. There is a halo benefit given that we are the one and only QQQ, so we will leverage that in the coming quarters.
Great. Thank you. Allison, as a follow-up on expenses—given AUM levels, you said 2026 expense target was $3.275 billion predicated on $2.3 trillion in AUM—can you talk about the variable component of expenses we should consider as AUM increases? Also, any update on comp ratio and net distribution or net service and distribution ratio?
Sure. On the distribution ratio, we think about third-party expenses plus distribution fees divided by management fees. That relationship matters when forecasting expenses. That ratio was 22.7% for the second quarter and also 22.7% in the first quarter. Going forward, it is fair to think of that somewhere in the 22.7% to 23% range, perhaps a little closer to 23% due to the product mix shift with growth in lower-fee products like QQQ, QQQM and RSP. For compensation as a percentage of revenue, we expect 2026 to be largely in the 40% context. We are halfway through the year and it has been a strong first half. We are cautiously optimistic for the second half, but the industry is revenue-sensitive. I think 40% is the right ratio to assume for 2026.
Great. Thank you.
Our next question comes from Brennan Hawken with BMO Capital Markets. Your line is open. You may ask your question.
Good morning, Andrew and Allison. Thanks for taking my question. Just a follow-up on the QQQ. The net revenue yield came in about 6 basis points better than prior guidance. Can you help us understand the primary factors that drove that delta? And it sounds like your outlook for that is unchanged. You are not planning on making any adjustments. Is that the right read? Or would you course correct? Thanks.
I would say consistent with the conversation earlier around fee rate adjustments, that is a longer-term thought process, but we are not near a reaction just given the strengths we have already discussed. The approximately 6 basis points delta is in line with where we were expecting and what we have been guiding to over the last couple of quarters when you think about the relationship from the effective fee rate to the custodial fees, the licensing fee, and variable expenses associated with marketing. That nets out to about a 6 basis point net revenue yield impact and similarly about a 6 basis point impact to operating margin.
Great. Thanks for that. And I believe you said the end-of-period net revenue yield was 22 basis points. Is that 22.0? Could you help us understand how that compressed versus the average?
Yes, the exit rate at the end of the quarter was 22.0 basis points. That is driven by the strong run in the back half of the quarter and some of those lower-fee products like QQQ, QQQM, and RSP. Given the flows and market moves and the lower-fee product mix, you saw an exit rate of 22.0 basis points at the end of the second quarter.
Great. Thanks for that color.
Our next question comes from Alexander Blostein with Goldman Sachs. Your line is open. You may ask your question.
Hey. Good morning. Another one on the QQQs. All the reasons you gave around the value the franchise created over time—the liquidity, tight bid-ask spreads—make sense. The concern is really the growth going forward. I want to zone in on distribution channels: how reliant are your gross sales in the QQQ on areas that can have more sensitivity to the management fee being lower, whether in a fiduciary capacity or advisory capacity? How do you think about that because the concern is more about forward growth as opposed to the back book?
Thanks for the question. First, the shareholder base is incredibly broad and cuts across every channel. Second, I would point you back to our proxy solicitation last year when we solicited shareholders to vote. That experience is indicative of the shareholder base's breadth and their focus on fee sensitivity. It was difficult to get some shareholders to vote for a reduction in their own fees, which showed how broad the shareholder base is. The bottom line is there is no single type of shareholder here.
Okay. Understood. One cleanup on expenses for you. You gave the moving pieces for this year, but as you look out into 2027, it is still a little noisy with implementation and that will roll off. How quickly do you expect the $15 million in implementation fees to phase out in 2027? Does it all go away in the first quarter or is it more gradual?
I would expect implementation expenses to start tapering off in the first quarter of 2027, but they will not all magically disappear on December 31. There will be some implementation that bleeds into the first quarter. Beyond that, implementation expenses should decline quickly. Then there is a lot of work to think about how to take advantage of the installation and manage our end-to-end delivery to extract greater operating leverage from our overall platform, which will be our real focus going into 2027 and extending into 2028. We are pleased to be at a 37.5% operating margin this quarter and the signal that sends about our ability to get back into the high-30s. Our focus will continue to be on positive operating leverage and how we generate profitable growth.
All right. Thanks so much.
Our next question comes from Brian Bedell with Deutsche Bank. Your line is open. You may ask your question.
Great. Thanks. I have one cleanup on expenses. I think in Q1 you said $3.275 billion was the expense target for 2026, predicated on $2.3 trillion in AUM. With the market trending better and AUM higher, can you talk about the variable component of expenses we should consider?
The most variable component is compensation relative to revenue. Compensation is about two-thirds of our expense base. I would point you to the 40% compensation-to-revenue guidance rather than a total expense-based guide because that relationship drives the largest variability. The guidance we gave was due to the sharp turn in AUM from March 31 to the earnings call at the end of April, and we wanted to provide expectations. But the biggest variable driver is compensation and that 40% relationship is the right way to think about this year.
That is helpful. Thanks. On long-term equity flows, you mentioned idiosyncratic liquidations. Can you talk about progress on long-term equity flows globally and any view on when you might turn positive on equity flows on a more sustainable basis?
Improving flow dynamics for fundamental equities is a major priority. That will come from improved performance and product quality, and market demand. Getting positive flows depends in part on the market environment. The idiosyncratic outflows this quarter were a couple of large institutional mandates that left and are not recurring. The goal is to get back into positive flows, but some dynamics will be tied to market-driven demand.
To add, we do see positive flows in certain strategies. The Global Equity Income Fund has been selling very well in Japan with flows this quarter of $2.6 billion. Our U.S. Value equity range had a second consecutive quarter of net inflows. Where we have good investment performance and secular investor demand, we are capturing flows. Returning to consistent positive flows is a challenge for the industry.
Totally makes sense. Thank you.
Welcome. Operator, we have time for one more question.
We have a question from Benjamin Budish with Barclays. Your line is open. You may ask your question.
Hey, good morning and thank you for squeezing me in here. One final one on the expense side. On comp in particular, in Q1 you had a couple of seasonal items like payroll taxes and acceleration of long-term awards. How should we be thinking about variable comp going to the back half of the year? It looks like Q2 stepped up a bit more than expected given those Q1 seasonal items. Any incremental color would be helpful. The 40% guide is helpful, but how do we think about it in the context of market moves?
From a seasonality standpoint, all things being equal, comp to revenue is typically higher in the first quarter, a little lower in the second quarter and then tends to taper off. The seasonality in Q1 is associated with payroll taxes and the way our long-term awards are recognized and deferrals, which creates a Q1 hit that drives the comp-to-revenue ratio higher. Some of that bleeds into the second quarter, and much of that washes out by the back half. Again, I would point you to a full-year guide of that 40% compensation-to-revenue relationship.
Okay. Thank you very much.
Great. Thank you. Thanks, operator. So in closing, we are absolutely pleased with the continued strong results this quarter. We advanced several strategically important investment capabilities and vehicles with many reaching record AUM levels. With disciplined focus on the benefits of scale, we are generating meaningful operating leverage and improving margins. We will continue to stay focused on our defined growth strategy with emphasis on relentless execution, client-focused innovation, and teamwork across our firm. Thanks to everybody for joining the call today. Please reach out to our Investor Relations team for any additional questions and we appreciate your interest in Invesco. We look forward to speaking with you all again soon. Thank you.
This concludes today's conference. We thank you for your participation. At this time, you may disconnect your line.