Q3 2021 Federated Hermes Inc Earnings Call
[music].
Okay.
Yeah.
Good morning, ladies and gentlemen, and welcome to the Federated Hermes analysts.
Excuse me the Federated Hermes Q3, 2021 analyst call and webcast.
At this time, all participants have been placed on a listen only mode and we will open the floor for your questions and comments after the presentation.
It is now my pleasure to turn the floor over to your host.
Ray Hanley President of Federated Investors management company, Sir the floor is yours.
Thank you and good morning, and welcome leading today's call will be Chris Donahue, Federated, Hermes, CEO, and President and Tom Donahue, Chief Financial Officer, joining us for the Q&A are soccer and a savvy who's the CEO of the international business of Federated Hermes and Debbie Cunningham, our chief investment officer for money market.
Yes.
During today's call we may make forward looking statements and we want to note that Federated Hermes actual results may be materially different than the results implied by such statements. Please review the risk disclosures in our SEC filings no assurance can be given to future results and Federated Hermes assumes no duty to update any of these forward looking.
Statements Chris.
Thank you Ray and good morning.
I will review Federated Hermes business performance, and Tom will comment on our financial results, including waivers.
Q3 ended with a record long term assets under management of 220 billion, including record assets in fixed income at 97 billion.
And in alternate private markets of $22 billion.
Assets under advice by Eos at Federated, Hermes, where one seven trillion at the end of Q3, we added one new client in the third quarter and six new clients year to date.
While equity fund flows were negative in the third quarter by $867 million. We saw positive net sales in <unk> equity fund strategies and added about $400 million in equity assets from the Hancock horizon transaction.
Our equity fund.
Performance compared to peers was solid using morningstar data for trailing three years at the end of the third quarter, 50% of our equity funds were beating peers and almost 20% were in the top quartile of their categories.
Equity SMA had third quarter net redemptions of about $15 million down.
Down from $160 million in Q2.
Down from $450 million in Q1 and down from $900 million in Q4 of 2020.
The domestic strategic value dividend strategy had positive Q3, SMA sales of $34 million and slightly positive combined fund and SMA sales.
For the first three weeks of Q4 equity funds and SMA had net redemptions of about $463 million.
Interestingly about three fourths of this.
Was a tactical shift five one client.
Okay.
Now turning to fixed income Q.
Q3 was another very solid quarter of net sales and performance.
Assets increased by $6 4 billion or 7% from the prior quarter with nearly all of the growth coming from net sales.
Fixed income separate account net sales of $4 6 billion were driven by multi sector strategies.
Most of the Q3 separate account net sales came from a large public entity.
Fixed income fund net sales of $1 7 billion were driven by short duration strategies of $1 4 billion with solid results in core total return strategies.
As well that's about $360 million.
We had 19 fixed income funds with net sales in the third quarter.
Now we are progressing towards the planned Q4 launch of our first two active transparent Etfs and.
And investment grade short duration, corporate bond fund and a high yield short duration bond funds.
These initial offerings draw on our strengths in these areas. We're focused on the successful launch and growth of these initial products. While we also plan for additional ETF offerings.
At the end of the third quarter end using Morningstar data for the trailing three years.
We had 28% of our funds in the top quartile and 44% above median.
For the first three weeks of Q4 fixed income funds and SMA had net sales of about $454 million.
Now in the alternative private market category.
Net sales were diversified across unconstrained credit.
$568 million.
Absolute return credit a little over $200 million.
Real estate $180 million and direct lending $68 million.
These additions are expected to occur in fixed income and alternative private markets, including the aforementioned unconstrained credit direct lending and trade finance.
Now we are working on two new private.
Markets products, we expect the initial closing.
For our new direct lending fund during Q4 for about $270 million and expect to raise additional assets in 2022.
We're also working on a new private equity fund with an initial closing set for Q4.
This will be a mix of existing clients rolling over to the new fund and some new clients, we expect around $300 million in the initial close with an additional capital raise two weeks two expected to occur next year.
Moving to money markets.
Assets were down about $16 billion in Q3 with about $10 billion from funds and $6 billion from separate accounts.
Our money market mutual fund market share, including sub advised funds was about seven 2% at the end of Q3 down slightly from Q2 of seven 4%.
While the fed raise the administered rates in mid June the money fund yield curve remains flat and rates didn't change much in the third quarter.
We believe that we will see higher short term rates in 'twenty two.
We continue to experience more waivers for competitive purposes, Tom will update this program as I mentioned.
Now taking a look at recent asset totals.
Managed assets were approximately 636 billion, including 413 billion in money markets 99 billion in equities.
<unk> 98 billion in fixed income and 22 billion in the alternative private markets and $4 billion in multi asset.
Money market mutual fund assets were $290 billion with that I'll turn it over to Tom Okay. Chris. Thank you.
Revenues for the quarter was up.
From the prior quarter due mainly to the impact of lower minimum yield waivers.
$8 6 million and an extra day in Q3, which increased revenue by $4 9 million.
The increased revenue of $5 4 million from higher average.
Fixed income and equity average assets was offset by lower average money market assets related revenue.
Q3 carried interest and performance fees were $5 2 million compared to $4 4 million in Q2.
Operating expenses decreased slightly in Q3 compared to Q2.
Most categories were lower or about flat.
We are seeing restoration and travel and entertainment expenses as pandemic related restrictions ease.
The negative impact on operating income for minimum yield waivers on money market mutual funds is currently estimated to be about 39 million for Q4.
Up slightly from $37 million in Q3.
Q4 estimate is based on our investment team's expectations for portfolio yields.
<unk> asset level asset mix and other factors.
The amount of minimum yield waivers and the impact on operating income will vary based on several factors, including among others interest rates the capacity of distributors to absorb waivers asset levels and asset mix.
Any change in these factors can impact the amount of minimum yield waivers, including in a material way.
During the third quarter, we completed the acquisition of BCP pension schemes remaining 29, 5% non controlling interest in Hermes Fund limited managers for $116 5 million pounds.
During Q3, we purchased about 600000 shares of our stock for approximately $18 million.
John that completes our prepared remarks, and we'd like to open the call up for questions now.
Okay.
Yes.
Thank you ladies and gentlemen, the floor is now opened for questions do you have any questions or comments. Please press star one on your Touchtone phone.
Pressing star two were removing from the Q should your question be answered and lastly, we are posing your question. Please pickup your handset listening on speaker phone to provide optimal sound quality.
Please hold while we poll for questions.
And the first question is coming from Dan Fannon.
From Jefferies. Your line is live.
Thanks, Good morning.
First question is on the fee waiver outlook.
Understand.
You mentioned that can drive the changes, but curious about the competitive factors and maybe what is different as you think about this cycle of rates and cut from competition versus previous ones than the relationships potentially between distribution expense sharing.
And the economics of that difference at this time.
As we come potentially back to a more normalized rate levels.
So yes this.
This is Tom.
Our competitive environment remains it has always remained and.
As rates as.
As we expect rates to go up over time.
We will remain competitive with the with the rest of.
The market is.
And.
Yes.
That's basically how we how we view it.
Okay, but I guess just trying to clarify then.
<unk> delta with assets being down rates generally being up but the fee waivers going higher can you give us the factors that are specifically driving that.
So the competitive the competitive discussion on that is not the minimum yield waivers are the waivers to maintain.
Zero or just above zero and the rates and that's how that's how we do it if we are going higher than that then that's really the competitive nature.
Nature and that depends on what's going on in the marketplace.
And we can't really predict what's going to happen there and Dan It's ray just to.
Jump down to the assets a little bit.
Detail.
At the end of the third quarter, the money market fund assets were higher than the average for the third quarter. So we.
At least entered into the quarter at a higher <unk>.
Average asset level.
<unk>.
With with government and the assets were up about $3 billion, but government funds were up about $5 billion and thats, where the bulk of the waivers happens so.
That.
We do our look ahead.
With those assets in mind.
Got it okay. Thank you.
Okay. The next question is coming from Ken Worthington from Jpmorgan. Your line is live.
Okay, Coincident said similar topic here on competitive fee waivers.
It looks like the yield on the government obligations fund rose in August and Roche in September to match yield levels by some other big government funds at say Blackrock and Goldman although there are some others as well I assume that this is a matter of competitive fee waivers that debt that we've been talking.
About.
And also to follow up on Dan.
I do know you've always said the money market fund business is always very competitive, but now that we're seeing more conviction around rate increases, possibly coming next year is they are jockeying, taking place to kind of try to to win share through through yield in a way.
Hey that maybe.
You and the industry didn't see six to 12 months ago before there was sort of conviction that maybe we might have higher yields happening in 2022, rather than 2023 or beyond so anyway, just maybe more of the same thanks.
Ken it's really hard to jump into the skin in the brain of the competitors as to whether they are trying to do something one way or the other and.
So we don't just do that we deal with the reality of the marketplace. What those yields are I don't disagree with your observations about what was going on in the summer.
And this game will continue I'll, let Debbie comment on some of the specifics of those of what was behind those rate moves.
Sure.
This is Gary looking at the various curves.
What's available the government funds, which as Ray mentioned our.
Generally the ones that are contributing to that highest amount and waivers.
We're constrained in the third quarter by what was going on from a debt ceiling limit and so that has unfortunately been kicked down the road a little bit and will be impacting us to a large degree in the fourth quarter as well.
You look though at other curves that are not being influenced by that debt ceiling constraints.
Youre looking at curves that in the money markets have generally resin anywhere from four to 10 basis points and our expectation would be as soon as we start tapering and got too high and the debt ceiling is behind us providing more supply.
The government car will fall out.
<unk> and <unk>.
Expectation from a competitor standpoint are that with them.
Expected increasing yield there is less of a concern about what needs to be enhanced.
Various shareholders in the marketplace and I think that.
What we're basically hearing and seeing that flip the calendar into 2020 to get the debt ceiling behind that get tapering underway.
And the government curve starts to look like the price curve, whether youre looking at LIBOR basically whatever the indices are and that means increasing rate.
Perfect. Thank you so much.
Okay. The next question is coming from Bill Katz from Citigroup. Your line is live.
Okay. Thanks, very much for taking the question. This morning, you were with them through some of the product launches a pretty quick. This morning, just wondering if you could repeat what you had mentioned in terms of the direct lending and private equity and how do those funds compare to predecessor funds and then a broader question, Chris that seems to be a fairly big focus on tapping into the retail democratization.
<unk> four alternatives I was just sort of wondering what's the what's your sort of go to market strategy to try and pick up on that opportunity.
Yes Bill.
In terms of those.
Various items.
There are two basic items one of course.
Is the direct lending and.
This brings us up to.
New totals and we will get into that in a second but what what what's going on here is a step out into private markets.
That was part of the sort of behind the curtain not in the first wave of enthusiasm for the Hermes deal in the first place and that the entire the private markets business in our view.
To obtain the similar size to really have a whole Federated enterprise was when we did the acquisition.
So.
We're very happy to see this private lending.
Proceed along and this is consistent with what's going on in the other Martin in the marketplace broadly as well.
On private equity.
We have a very very good set of investors there and as I.
I said, we expect around $300 million in the initial close.
And that brings us up to some pretty tidy figures as well.
And so I'll, let ray give you those numbers and then I'll have <unk> talk to you about.
The whole effort from his point of view as well Yeah, Bill just on the <unk>.
The activity we expected in.
In Q4 on the direct lending.
We will have funding in the 300 million range.
Which would bring our total direct lending assets to about 700 million Euro.
And then we're looking at.
<unk> asset rates for that product.
Just year, so that will stay open and continue to raise.
On the on the private equity side this would be another iteration.
Of what.
What we've done to date.
And.
We expect as we said about $300 million in the initial closing from a mix of rolling over existing clients staying in and some new.
Investors as well and that vehicle will also look to raise additional funds next year.
<unk>.
Thank you very much.
So in terms of the whole private markets business, we have a very strong footprint across the firm and private markets gain from property through two infrastructure through to private equity through its direct lending.
Unconstrained credits and we view this as a singular platform, we are increasingly working on being able to present that to our clients as one so that they can choose on various facets within its specific you're talking about.
What went through and what Chris talked about the direct lending fund typically works.
And vintages that close the fact is that we've raised the first part of the vintage faster than we'd anticipated and the flows look as you've just had to be strong and we expect to continue raising assets pull that into.
Next year and for next quarter I would say it is what we call. The team one of the best in the business According to Minneapolis.
And the performance has been strong.
And the pulse, which is why we continue to see this flow through the private equity team is very well established team and this is again, a new vintage that they've raised.
We're hoping to raise taxes the tube.
That's about it.
From an equity.
Real estate I've talked to you in the past the two kinds of real estate, we do it's particularly U K focused one is.
Funded unit trusts and equivalent to what the Americans, we call the mutual fund.
That continues to have the best track Records.
10 years and continues to attract capital but in addition, we have these development projects, which we called place makings, which have had outstanding returns and to continue to attract assets.
We're pretty we're pretty.
Confident that we will continue to see clients coming into this but it tends to be.
The big chunks, one off so they don't seem to be sort of disputes of it as far as your question of how do we democratize.
The access to private markets. It is something we're working on we're not yet because it's come to the market.
Talk about how we're doing it but it's certainly something that we.
Do think about and were thinking about how to make capability available.
Different ways.
It is combined with very strong business with.
The projection for growth as Chris has said.
Which is quite substantial.
I will turn it to Chris.
Thank you.
Thank bill.
When we purchased the Hermes and had all these exciting businesses.
Soccer and his team developed those.
The relationship with the pension scheme and.
What we've talked about now is how do we institutionalize this and make it avail.
Available to abroad broad group and that's going to go.
We're coming down the path to being faced with adding some distribution and other operating expenses that will come along in this business next year, so, but we continue to be pretty excited about it.
Yeah.
Thank you.
Okay. The next question is coming from Kenneth Lee from RBC capital markets. Your line is live.
Hi, Thanks for taking my question.
One just around the competitive landscape for money market funds wondering.
It's part of the competitive reasoning is seeing any clients going to either.
Money market fund substitutes.
Thanks.
Well it seems as though deposits are always in the picture. Unfortunately.
Hum.
Money market competitive product and even in today's low rate environment, where there are substantial amount of the deposits that are uninsured and that our non interest bearing that seems to be nonetheless, a choice.
Many of our clients as far as other types of products I know lots have been mentioned as far as Etfs cash like Etfs.
Crypto currencies, we're not seeing that occur at this point, we are we have those on our landscape as something to watch.
We're certainly.
Understanding and involved in the market so that it doesn't creep up on us and.
Become.
Distinctive competitor before.
We recognize that but that's not necessarily anything we're spending at this red Hot moment in time, and Ken just to add to that.
Our saying of course clients corporations, putting cash to work investing as we are.
Enter an up cycle and come out of the pandemic. So we will expect to continue to see uses of cash whether that's.
Stimulus money that's.
Load through and flowed into money funds and eventually goes on to do it.
Tended stimulus work.
As well as as I mentioned corporations.
Beginning to invest in.
Seeing opportunities, where they were more hunkered down over the last 18 months and one last thing Ken is that in the context of our.
Micro shorten our ultrashort products.
There have been clients that have over the course of the last two years with Alterra low rate contained.
Continued to bucket cash and got a little bit longer into those products. In addition.
That are concerned about a steeper yield curve and higher rates than that in the long end of the curve have also come in to those products.
But again.
With a full lineup of funds that go from basically overnight out to 30 years.
We're we're liking that slowed.
Great very helpful.
And just one on the private markets direct lending fund Wonder if you can just talk a little bit more about how the underlying economics work for Federated Hermes.
And then perhaps.
It sounds as if it is a very experienced team there just wondering in general.
How does the fund can compete against perhaps some other players that do direct lendings through permanent capital vehicles.
Well I can comment just broadly on the fee levels for alternative private market and.
And soccer could address the competitive landscape for direct lending.
Essentially.
Our private market alternative businesses as blends in at around just under.
40 basis points and that does not include performance fees and carried interest which come alone.
Episodically.
And.
That's a range of strategies.
Wouldn't comment on particular fund levels for particular slices of that at this point.
Soccer do you want to talk to the competitive landscape.
Sure. So I mean, you're right. There are many different direct lending funds and if it said that I think what differentiates us is three things.
First thing is the team.
Leadership of Patrick motion.
Quickly experienced team, particularly in the lending space.
All the way back to the financial crisis.
Yes.
Canada is another way at the second one is the methodology of assessing loans and slightly different not least because as.
You've heard from both Chris and myself and the pulse into.
Integrating ESG factors, we believe that sulfur and we believe looking at Stuart's effect is also add so hopefully it gives you insights.
And we think that allows us to continue to have a competitive advantage against.
Does it make it more attractive to buyers, particularly in Europe and the third way is the way that we source the loans are a little bit different from the marketplace. We can take this offline, but we have a slightly different model, which we think is particularly successful so we're pretty certain when we approach clients.
And we've seen this very much so.
In Europe it is.
Very strong proposition and that is due by the fact that whenever we launch new launches we have so far managed to build the first to take the questions very quickly.
I'm.
Could this happen, but we do have a strong competitive advantage.
Thank you.
And I would I would add on the PE side.
The way you phrased the question you had.
Got it.
The private equity and direct lending funds, they're not together, they're completely separate each individual funds and on the PE side.
A unique way of offering that has gone on quite successfully for a long time originating obviously with the pension scheme, but growing into.
Third party investors with a club like approach of investors and our very thematic approach from the investment advisory side of it.
Coupled with the ESG integration and so in each of the direct lending and the P/e.
<unk>, what we think is a unique flavor that allows us to be enthusiastic for these offerings.
Great that's very helpful. Thanks again.
Once again, if you have a question or comment please indicate so by pressing star one on your Touchtone phone. The next question is coming from Patrick Davitt from Autonomous Research. Your line is live.
Hey, good morning.
One more follow up on that so.
So am I hearing correctly that the private equity strategy doesn't have kind of like vintages like we used to with.
The alternative asset managers recover.
And through that later because it.
Almost an evergreen type strategy that can kind of always be raising money could you give us is that the right way to think about it.
So it does have introduced but it told us vintages methodology as Chris said this is what really matters in the private equity business again.
I'd like to emphasize it's Lee.
I lead the investor the team that has the stomach track record going back many years in the public domain. So you can check it out.
They develop this very differentiated way of accessing deals in private equity markets. The second element is this again very differentiated domestic overview that they put on them now.
While we typically do with all of these strategies in private equity is we launched different vintages of funds and that's what we're looking to do as we go forward and quite often this is.
Performance is no guarantee of future, but quite often clients who are in the previous vintage were rolled over into the next vintage.
Private equity has to live with vintages, because think about it what happens is once you invested private too, but there comes a time when you set a tone, that's how you realize the appropriate and hopefully.
The Curry two.
Hope that answers it quite like it doesn't sound like there's like a Hermes fund five or <unk>. Following our Hermes fund four is that correct.
It sounds like because the Hermes funds.
Thanks.
Yeah, Let me, let me answer that.
Yes, you do named them like that but is far better for us not to talk about the names just yet because of legal constraints, but that is exactly what happened can.
Can you tell us the size of the previous funds.
So I will come back.
And get to with that yes, I'll do that alright last question.
Any color on on how to think about the incremental earnings impact from having a full quarter of the new Hermes ownership in <unk>.
I think we went over that last time that you.
There is small.
Small sense involved.
Got it.
Yes.
<unk> side of things and.
Soccer rate does have the numbers from the previous equity funds.
And Patrick as he doesn't mean, they're as committed capital on invested capital and at the last read around mid year, we had about $850 million.
In that fund that there was more than that about twice that.
And so I don't have any more recent figures there may have been additional investments made.
Over the last quarter, but that gives you a.
Rough dimension.
Thanks.
Okay. The next question is coming from Robert Lee from <unk>. Your line is live.
Great. Thanks, Good morning, good morning to everyone.
That's my first question is.
And thinking about.
Expenses heading into next year now.
No no.
Thank you Don.
I have no interest in giving guidance or anything, but just kind of curious kind of generally.
And he's coming up investing in our private markets business I assume you're seeing like the rest of the U S industry pressure on compensation costs. So if we're thinking into next year, putting aside any fee waiver impacts on distribution expenses and whatnot.
How should we be thinking about kind of comp growth into next year is that right.
Inflation rate plus a reasonable spread I mean, how are you kind of did you have to be getting close to your budgeting process now how should we be thinking of it next year.
Yeah.
So.
If we just go back and read your question.
The answer.
Being funny, but yeah, you got you got most of the subjects that start out with this on.
Just looking at this quarter and into Q3.
Inflation is real.
Going to affect us.
Incentive comp versus run rate benefits.
Our tech continuing to invest in.
And in the operations here.
Market data, particularly ESG related.
Professional service fees, that's just going to be inflation.
Office and occupancy why does that go up well, that's basically returned to the office.
That we expect to be happening more.
Advertising and promotion and our advertising and promotion line.
That's conferences, which what is that that sales meetings, and we certainly hope and expect that to tick up.
And then.
Travel travel and entertainment are.
Traveling related which is our salespeople and investment in people and others going around visiting clients and visiting companies. We have seen that tick up in Q3, and we expect it to go up in Q4 and all of those same things I think will also affect next year.
Clothing.
Furthering our private markets business.
Okay. Thanks, and then.
Going back to the private markets, but maybe a little bit from a different angle. So.
Obviously, there was a big notable one yesterday, but obviously a lot of.
Managers like yourselves or expanding that type of markets capabilities in different ways.
But from a capital perspective, you know private market strategies often take.
Bigger commitments of capital whether it's the.
For GP commitments to funds or to seed new strategies, and I guess b piece of some of that purpose in the past, but do you envision this being a bigger use of capital to kind of.
Celebrate growth of that business and then part two of that would be.
You do think about M&A.
On M&A.
Some of that.
Kind of an increased focus to find complementary or scalable.
<unk> businesses as well.
Yeah.
Yes.
So on on capital each of our teams has talked to us about how exciting it will be for Federated Hermes, Inc. To make an investment in there as a as part of the process as show good faith to help a capital raise and of course, we'll make a lot of money.
With this investment so yeah, Rob I would expect us to be to be doing more of that.
In terms of M&A.
It's hard to.
Buy those businesses and we really are very fortunate to have a.
Purchased Hermes in the half.
Each one of those lines of businesses in and shapes.
Shapes that we could.
Grab hold of it structure it together as I said before institutionalize it gets and distribution teams growing.
And go out and and move it further and further away from from just the the original investor of which Hermes has already soccer team.
Its already done a lot of it but we expect a lot more and that's a lot more that's a lot easier to do since we already did make the acquisition.
But we do have our team.
Out looking and how do we bring things one of the interesting factors is how do we bring.
This is <unk>.
For areas five areas that <unk> talked about to the U S.
And what what would we need M&A to do some of those we have considered and we'll we'll look at various opportunities there.
Just their hard they're hard to do.
Yes.
Great. Thanks for taking my questions. This morning.
I'd now like to turn the floor back to management for any closing remarks.
Thanks, John that.
That concludes our call for today and we thank you for joining us.
Yes.
Thank you ladies and gentlemen, this does conclude today's conference call. You may disconnect. Your phone lines at this time and have wonderful day.
Your participation.
Yeah.