Q1 2022 Federated Hermes Inc Earnings Call
Good day, ladies and gentlemen, and welcome to the Federated Hermes Q1, 2022 analyst call and webcast. At this time all participants have been placed on listen only mode and the floor will be opened for questions and comments. After the presentation. It is now my pleasure to turn the floor over to your host Ray Hanley.
President of Federated Management company, Sir the floor is yours.
Good morning, and welcome leading today's call will be Chris Donahue, Federated Hermes CEO and president.
Tom Donahue, Chief Financial Officer, and joining us for the Q&A are soccer to save me the CEO of the international business etcetera, Hermes Federated Hermes limited.
And Debbie Cunningham, our Chief investment officer for money markets. 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.
<unk> can be given as to future results.
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 over the quarter and Tom will comment on our financial results.
Looking first at equities for the Q1 total net redemptions were $78 million.
Down from the prior quarter's $2 7 billion.
Equity separate account net sales were a positive 80 million well equity funds had net redemptions of about $158 million.
Each showing improvement from the prior quarter.
Notably.
The domestic strategic value dividend strategy had.
Q1, net sales of about $933 million with both the fund at $442 million in the SMA at $490 million producing solid net sales.
We saw positive net sales in 18 equity fund strategies, including several international equity strategies, such as Asia ex Japan.
S D G engagement international equity international strategic value dividend.
Global equity ESG.
Impact opportunities back on the domestic side the MDT small cap core fund also produced 127 million in net sales.
Not surprisingly net redemptions were concentrated in growth strategies, reflecting difficult market conditions for these activities.
With inflation concerns prevalent the area of focus of our equity business include asset classes and strategies that have responded well in the past inflationary periods. These include dividend income international emerging markets and value strategies.
The Q1 sales improvements were concentrated in these categories.
Our equity performance at the end of the first quarter compared to peers with solid.
Using morningstar data for the trailing three years at the end of Q1, 61% of our equity funds were beating peers and 39% were in the top quartile of their category.
Now for the first three weeks of Q2 combined equity funds and SMA had net redemptions of $109 million.
We had 21 equity funds with positive net sales in the first three weeks of April including the strategic value dividend.
The international strategic value dividend fund global equity ESG impact opportunities and international equity.
Now turning to fixed income.
Q1, net redemptions were about $2 billion.
Net sales of just under $1 billion in fixed income separate accounts were offset by 3 billion in fixed income fund net redemptions.
Our fixed income separate account net sales of just under $1 billion were driven by multi sector strategies.
Within fixed income funds.
The three short the three ultra short funds had net redemptions of about one 4 billion.
The institutional high yield bond fund had about $750 million of net redemptions.
All categories of bond funds had debt redemptions, reflecting market conditions.
However, we had 17 fixed income funds with positive net sales in the first quarter, our floating rate strategic income fund the STG engagement high yield credit.
Climate change high yield credit strategic income inflation protected securities.
Short term government.
Total return Bond fund and Conservative municipal micro short.
Regarding performance at.
At the end of the first quarter and again using Morningstar data for the trailing three years, 61% of our fixed income funds were beating peers and 19% were in the top quartile of their category.
For the first three weeks of Q2 fixed income funds and SMA had net redemptions of about one $1 billion.
In the alternative private market category.
Net sales of $139 million included real estate of $215 million.
Direct lending of about $57 million Pru bear about the same number.
Trade finance $30 million and these were partially offset by net redemptions in private equity and in infrastructure.
So we begin Q2 was about 1.1.
Billion in net.
Okay.
Institutional mandates yet to fund into both funds and separate accounts.
Additions are expected to occur in alternatives private markets, including private equity unconstrained credit and direct lending.
Fixed income wins include core flexible credit and government debt strategies.
Moving to money markets.
Assets declined about 27 billion in Q1 compared to UN totals.
As money market fund assets decreased by 33 billion and our separate account money market assets increased by about $6 billion.
Our total money market assets at the end of Q1.
We're just above the total that we had at the end of the first quarter of 'twenty one.
Seasonal trends impacted both money market funds and separate accounts rising interest rates and competitive pressure also impacted money market fund asset levels.
Our money market fund market share, including sub advised funds was about six 9% at the end of Q1 down from about seven 4% at the end of 2021.
And with the first fed hike last month and a series of additional increases expected.
Money market fund minimum yield related fee waivers decreased in Q1 Tom.
Tom will update us on our yield waiver outlook.
Market expectations are that the fed will increase the pace of interest rate hikes, why we welcome higher money market yields.
We believe that measured increases would be better for money market funds compared to direct investments.
However, though more rapid rate increases may initially favorite direct investments, we believe that higher short term rates will benefit money market funds over time, particularly compared to deposit rates.
And we've noted this in history.
We said during the last quarter that during the last fed increase cycle that began in Q4 of 16 through the last rate hike in Q4 of 18.
After an initial decline our money market fund managed assets increased by 15%.
The industry, followed a similar pattern.
With an initial decline followed by a growth of 11% over that same timeframe.
The higher rates helped us continue to grow these assets by an additional 22% through the third quarter of 19, when the fed began to ease.
Industry money market fund assets also grew in this period, showing a 14% increase.
Now on the regulatory front.
We recently filed to comment letters with the SEC on their proposed money market fund rule changes, including our primary comment letter of 115 pages and a separate 45 page letter on the deviance of swing pricing.
Our comments and those from others note that swing pricing is not a workable alternative for institutional prime and Muni money market funds. We believe that most institutions would not use these products if swing pricing were to be imposed.
In addition to uncertainty around redemption proceeds from our clients' point of view large scale system changes would be required by money fund managers and intermediaries and investors to even enable swing pricing to function and.
In our view.
<unk> if any will undertake these efforts.
As a result, we expect that most of the assets currently in institutional.
Prime.
Municipal money market funds would shift to government money funds.
As many did with the last round of changes in 2016 or move to products like our private prime liquidity funds that are not subject to money market mutual fund regulation under to a server.
We have approximately $8 billion in client assets in this category of institutional Prime and municipal funds that we believe would be impacted as swing pricing were to be imposed.
As the SEC is proposing.
We also commented that the SEC proposed requirement.
Is that stable NAV money market funds convert to a floating NAV or future market conditions resulted in negative money market fund yields would lead to material outflows from U S government money funds to bank deposits or again other Reg is nonregulated investment products.
Sure.
Now taking a look at recent asset totals.
Managed assets were approximately 617 billion.
Including $413 billion in money markets.
87 billion in equities 91 billion in fixed income.
$22 billion in alternative private markets and $4 billion in multi asset.
Money market mutual fund assets were 269 billion.
Tom.
Thanks, Chris.
Total revenue for the quarter increased 1% from the prior quarter due mainly to lower money market fund minimum yield related waivers.
An increase of 34.3.
$3 million and $2 million from higher average money market assets.
Offset by lower average equity assets, reducing revenue by $17 4 million.
Fewer days in the quarter, reducing revenue by $9 3 million lower carried interest and performance fees of $3 6 million.
And lower average fixed income assets <unk>.
Reducing revenue by $2 4 million.
Q1 carried interest and performance fees or $100000 compared to $3 7 million in Q4.
Operating expense increased 3% in Q1 compared to Q4.
Looking at compensation and related expense about $7 7 million of the $9 9 million increase from the prior quarter was from severance seasonally higher stock compensation and payroll taxes.
Other factors included incentive compensation and base salary increases.
Higher distribution expense.
That mainly from lower money market fund minimum yield waivers.
Advertising and promotional expense decreased due mainly to the timing of our AD campaigns.
Okay.
The short term rates higher in Q1, the negative impact on operating income for minimum yield waivers on money market funds decreased to about $18 million compared to $38 million in Q4, we expect that Q2 negative impact too deep.
To decrease to about $1 million.
Nonoperating results after subtracting the impact attributed to the Noncontrolling interests reduced earnings per share by about <unk> <unk>.
Due to the negative market impact on investments.
At the end of Q1 cash and investments were $457 million of which about $418 million was available to us.
Debt at the end of Q1 was 397 million <unk>.
Including the $350 million of long term debt added during Q1.
Net cash and investments were $20 million at the end of the quarter.
During Q1, we purchased over 3 million shares of our stock for approximately $102 5 million.
Paul that completes our prepared remarks, we're happy to take questions now.
Certainly ladies and gentlemen, the floor is now open for questions. If you have any questions or comments. Please press star one on your phone at this time. We are still are posing. Your question you. Please pickup your handset desk listening on speaker phone to provide optimum sand quality.
Once again, please press star one on your phone because you have a question at this time.
Please hold while we poll for questions.
Okay.
Yes.
The first question is coming from Patrick Davitt from Autonomous research.
Patrick your line of lives.
Hey, good morning, everyone.
The first question is on the comments around.
The flow from deposits into money funds Schwab recently called out.
This cash sorting as being an issue for their deposit accounts. So could you kind of square that through the lens of what you just said it.
Maybe Debbie give us an update on your thoughts of when you could actually see a more aggressive rotation from those deposits to your money funds.
We do get a more aggressive that is it looks like we will.
Certainly Patrick and I think what Schwab was talking about they're not putting words into their mouth is that deposit products number one gel follow interest rates.
In an upward fashion on a one on one basis the deposit beta for the last time interest rates rose was about 20%, meaning that for every 1% the fed raises rates deposits went up 20 basis points.
The other side of that equation, I think that exacerbates things along the lines in this particular.
Environment is that banks have.
More cash than they actually need at this point.
Or what.
And the demand for that cash is not high so they have no real incentive to attract cash by increasing their rates more quickly than they otherwise would so I think both of those towers to be problematic for those that are offering.
Deposit type products on the other hand, when we look at what the yield curve is is providing us with right now what it may provide us with us as investment opportunities next week after the fed meets.
We think that those are pretty substantial disappointment, especially since the fed as expected and we would expect them to increase rates.
At a minimum of 50 basis points next week.
And then following suit with another 50 basis points more or less likely in either June or July youre.
Youre going to see the return on money market funds.
Following that fed increase quite quickly generally speaking as the yield curve anticipates prime and muni funds that have a little bit more of a latter approach or they have longer securities generally in a more buyer about fashion.
Out the curve does.
Catch up more quickly before that that movement actually occurs whereas government funds, which have more on an overnight basis in the repo market.
Generally speaking catch up much more quickly as soon as the fed increases so.
At different points throughout the cycle.
Certainly the fed the fed meeting cycle, but generally speaking in a rising rate environment as long as it's fairly well telegraphed fairly well anticipated and certainly what we havent disappointed a fed that's trying to do that.
And communication is key you end up with money market funds following quite quickly.
In the path of rising rates and reflecting those higher returns back to customers.
Okay helpful. Thanks, and just a follow up on the flow guidance you gave.
I just want to confirm is that through April 22nd you said the first three weeks and could you also give us the multi asset and alts flow through that period.
The answer the first question is yes April 20 <unk>.
And the answer to the second question is about to arrive.
Okay.
Yes, the multi asset would be about negative.
15.
And.
The alts as positive about five.
Thank you.
Thank you.
The next question is coming from Bill Katz from Citigroup Your line of lives.
Okay. Thank you so much.
Question on the money markets for a moment unpack a little bit why your market share went down as much as it did a.
Quarter on quarter, maybe year on year, and then as you sort of think about this rate cycle is more recent rate cycle, the better cycle or should we go back to 1994, and if you have that kind of perspective I was wondering how is behavior of money markets in that prior cycle. Thank you.
Good morning Bill.
On the competitive thing there have been several features one is the normal amount of money that goes out for taxes.
And I think we have more than the average bear.
So that was a factor another factor is of course, the competitive landscape, where others are waiving more than us and our yields are where they are and that's what we've talked about before in terms of competitive situation.
But overall.
As you know, we don't end up losing clients on that score as too.
How we look at the bounce back it has to do with what Debbie was just talking about and what I mentioned in my remarks.
What we've seen is that when the rates get big and real.
They get caught up and as Debbie points out the banks don't want the money you can't use the money and don't want to have it anyway, because they would rather have a good deposit beta.
You get a spring back on the money fund assets re bill I don't have the nineties data but.
Back in <unk> for which.
Mid <unk> for the fed raised by 'twenty five and then a series of 50 basis point hikes.
Through for the next two years.
Our assets initially decreased.
That time to fund assets went into that upgrade cycle at about 123 billion.
Went down about.
10, 10 plus billion.
And then came out of that with the last fed movement up 50 basis points in mid <unk> six we were up <unk>.
Pushing 150 billion so the cycle.
<unk> was about the same back in that timeframe.
Yeah.
Warren against comparing to the 94 cycle Bell just simply because.
Very different fed back in 1994 number one but number two there were a lot of other things going on in the market during that timeframe. When there were unexpected 75, and 100 basis point increases in rates and they were basically derivatives floating rate securities that were in the marketplace and our floaters with what was happening then 10 year CMT fly there is non dollar based.
<unk> all of those things are causing angst in the money markets and they've all been parched at this point, so I think I would hesitate to compare to that time.
Okay. That's helpful perspective, Thank you and just as a follow up just coming back to a long side long only side of the business.
No I appreciate that you have good sort of Morningstar performance at least on the top half, but maybe two part question why do you think youre getting better traction in the separate account side separate managed account side versus the mutual funds and then when you break down your Morningstar categorization first quartile for equity and fixed income is pretty thin.
Does that have an impact on sort of go forward sales. Thank you.
Okay.
Bill on the equity side.
The.
<unk> you see this quarter of course is driven by strategic value dividend and.
If you look on the.
Funds side.
<unk> consistently said that the Morningstar Caddock category <unk> large cap value is not really a good fit.
And so the funds produce pretty solid net inflows as well in this cycle.
With the rotation into.
More of an appreciation of a.
Of a high and growing dividend income stream so.
We tend to think that the portals in the rankings are sort of the be all in and they certainly are very important but in this particular case, where the strategy thats been around now for decades.
<unk> sold through intermediaries, who understand what it is and how to use it and how it what it's places in the portfolio, it's a little bit.
Different than than some of the others in the <unk>.
Other thing to talk about what the fund flows is why we go through them. There's a whole series of international equity products that are.
Consistently over the last year or so producing solid.
Net net inflows.
The diversification of our equity business.
Sometimes that doesn't come to the fore because.
Because we've been in a period, where it's been challenging for four for the domestic growth side, but.
We have certain categories that are doing quite well.
That does not always lead up to the Morningstar rankings.
And Bill overall as I mentioned, when you have 39% of the equity funds in the top quarter quartile over over a three year period Thats pretty good we always aspire to more than that.
But thats a very good situation.
Then if you look at the sales of the funds, which now we're not talking net we're talking gross.
During the quarter, we had just about $7 billion worth of sales which is.
More than in December by a great amount and a hair less than it was March a year ago and so when you look at that over time, if you were to <unk>.
Annualize those numbers that we have this this is this year would be one of our best years ever in sales of equity products, that's really hard to <unk>.
Forecast all of that but one way to look at gross sales is whether the marketplace is seeing youre alive. That's why we mentioned the.
The fact that we have.
So many individual funds with positive net sales, namely 18 during the quarter.
Thank you very much.
Thank you and the next question is coming from Robert Lee from K B W. Robert Your line is nice.
Great. Thank you.
Good morning, everyone. Thanks for taking my questions.
Maybe the first one is going back to the competitive environment in money funds and it maybe want to look at it from the angle of.
The industry is certainly consolidated a bunch over the years you know maybe some more even since the last cycle. So.
Thinking about I mean, how do you kind of view that there's a lot of theres fewer but larger players do you think as.
Rates go up and money starts to flow back to the industry do you see.
More rational players in the sense that Gee you know, there's there's always competition on price, but do you feel.
Better or worse about the competitive environment as money starts to flow back.
B those out there who try to.
Pick up more market share than they used to on price I mean, how do you kind of think of that competitive dynamic.
Rob Chris.
Really hard to say better or worse since it's so constant.
How other competitors will react on pricing is something we don't really.
Have discussions about for obvious reason so you got to just look at it in the marketplace.
And there will always be competitors, who want to increase footings or are working on individual <unk>.
<unk> as the idea as opposed to.
What we would think would be a more rational way to run the business.
And we like to look at it in terms of market share of.
Revenues.
As another feature not just market share of the assets, although market share of the assets is important.
And so and when you talk about consolidation.
My suspicion is you will have more of it.
Is weather.
Especially when you have the higher rates people.
Traditionally look at these things so long and then they throw in the <unk> at some point and as I've said here a lot of times, we're a warm and loving home.
For anyone who wants to.
Get out of the money market fund business.
And I think we are well appreciated in the marketplace for that win when people.
I think it's time to throw in the Tau on that.
Robert one additional kind of positive aspect.
What Chris was mentioning initially.
In the regulatory response to the proposed rule two seven changes for the tune that is problematic propel.
Proposals that was being swing pricing for institutional prime and Muni and F. NAV for all products, including government at retail the industry was pretty much a July end and a voice, saying both of those things are not workable I mean, there were a few outliers, but very few.
I think that that's a positive in that we attempt to.
Work together for things that are really product and market changing.
Great and maybe as a follow up on the capital usage capital management. So.
I mean, if I think back historically, you know generally you haven't taken down that you don't have.
Too often except for maybe a transaction or so yet you know obviously you put some more debt on the balance sheet share repurchases. The last two quarters have picked up.
How do we think about.
It's about capital usage going forward is there a greater appetite for looks it seems like theres, a greater even greater appetite for repurchases and there used to be.
And then maybe a second part of that.
On capital usage, you know a lot of your peers have felt the need to ramp up and scale up in the alternative business has obviously been a bunch of acquisitions of different sizes could you maybe update us on your thoughts.
Will that be a competitive need or not something you need to go out and spend a bunch of money on.
I'll do the alts part and I'll, let Tom do the capital part so the second question first on alternatives.
Yeah.
When we did the Hermes acquisition there were some beautiful things inside that acquisition that werent than currently discussed in broadcast and that was the alternative business of real estate private equity.
Infrastructure and private lending.
And so.
What we're doing this year is building up the platform for those activities to present to the marketplace.
And the reason we're doing that is because in the old days under old Hermes They had one or two clients big pension plans and so the customer service angle was pretty simple if somebody called you got the information and you pass it on but it didnt create a platform that you could therefore broadcast of the world.
And so that's what we're doing right now as a way to build up the alternatives. If you look at the performance of the equity.
The private equity and the real estate, that's been put together, it's been outstanding and I would like.
<unk> and <unk> to comment on these and his views on how these alternatives and how the platform is going and then we'll have time come back and talk about capital.
Okay.
Thank you.
So if you look at the alternative businesses, we've got and you look at something like real estate or private equity we have a long provenance with very strong performance and very strong relationship with several very large pension scheme.
But as Chris said it was in fact limited to a smaller number of very large.
Very large investments the second point is we ran them in deals.
Okay.
We read them effectively as separate units and what we're doing is we brought together all of our private market assets as Chris has mentioned that includes direct lending. This includes also infrastructure one platform. So that because we think in the alternative space. There is place for clients wanting to allocate to <unk>.
Such reversals were building a platform we are increasing our sales exposure and we think we have a very strong proposition to bring to the market had in fact, our clients that we do have continued to support a buyback.
<unk> reinvested alternatives as we go through so it is very much.
An area, where we have where we are.
Growing and where we think we're going to see further growth in the future.
Rob This is Tom on the.
On the debt and shares.
Sickly.
Looking at interest rates and our teams here correctly expected rates to go up so.
Walk in.
The 350 on a fixed basis.
We historically have not wanted to borrow money just to have it and so.
<unk> is a confluence because we have been very bullish on.
And the marketplace. We don't believe has reflected that vis vis lower stock price than we think is appropriate.
And.
Our.
Free cash flow growth rate models.
And the stock looks like we should bias.
Pretty pretty actively which we have done and we actually.
Terms of we closed on that $3 50 in March, but we bought the shares.
Back when.
In December in Q4, and in Q1 as you saw so were <unk> 7 million shares purchased we still think the price does not reflect our value and we think it's a compelling purchase. So we are going to continue to be active buyers of the stock.
Great I appreciate the answers thanks, so much.
Yeah.
Thank you and the next question is coming from Ken Worthington from Jpmorgan. Your line is lives.
Hi, good morning, Thanks for taking the question here, what I really wanted to do is dig a bit more into the Kaufmann franchise.
And what I'm really trying to get after is sort of.
How I should think about the margins for that for that business now I recall Comping runs pretty lean I think Larry retired a number of years ago.
But I think Hans is still active I guess, maybe first is that true.
Give me a sense of how many investment professionals work there that would be great and then lastly, I think you walked off the direct distribution, you know years and years and years ago, and thus distribution for Kaufmann as all sort of centralized at that point I just wanted to confirm that that was the case as well.
Let's go in reverse on those the distribution is.
Right through the normal regular distribution at.
At <unk> and as you do to flee note. This was part of the standard pattern that we followed when we acquired areas of excellence to allow the investment manager to do their thing.
And then we take over the distribution and other aspects of it much like what we did with the PNC deal.
Our MDT or any of those.
As for Hans He is still very active and you can't make them non active E. J. He's one of these great analysts portfolio managers, who just has to have it.
And as you know since we've been discussing this forever there has been a lot of discussion around succession.
We have very good plans in place.
Mr. Ed injure it has taken on various leadership roles in that along with Hans and so we have a very good set up over there.
In terms of what's happened with the performance naturally it's not like we would like but as you can imagine.
When theyre heavy in biotech.
Not big on on the energy side.
Yet the kind of results you have right now they've had those kinds of results before.
And they continue to buy.
Companies, which they believe are good growth companies for the long term.
We recently opened up the small cap Kaufmann fund.
This week, we had a couple of $10 million trades and it is people wanted to get back in because of the buying opportunity that people, who long term C that franchise and that approach as a worthy part of their portfolio now that isn't going to turn the tide on.
On redemptions in that fund, but it certainly is a positive indication to how some clients.
Look at that.
As to the.
What was the other question.
Ray.
Yes, so IC investment team.
What's interesting is how much continuity theres been really over the.
20, plus years now that we've been together and expanded the product line the sizes around a dozen investment portfolio managers and <unk>.
Very senior analysts and that number Hasnt hasnt changed.
In the last several years and as to the margins, we don't do individual margin analysis of <unk>.
Segments of the business, whether its kaufman, our MDT or equity or fixed and equity.
Just don't do the numbers that way and so.
It's.
I just don't have a comment on the margin.
No that was it all trying to figure out myself. Thank you. So much it was an amazing deal.
So.
Just wanted to dig in given all that's going on in growth. These days. So thank you very much.
Thank you and we did have a follow up comes from Patrick Davitt from Autonomous Research Patrick Your line of lives.
Hey, guys. Thanks for the follow up.
On strategic value dividend in the past when it's when it's put up performance numbers like this.
Took in a ton of net new flows I mean, it seems like we could be in the beginning stages of that again, given the <unk> experience. So through that lens is there is there kind of a building pipeline of SMA mandates a shadow pipeline building, there and could you maybe frame that versus how it looks you know a quarter or two ago.
There is great interest in in this particular.
Mandate.
And I don't have an eye on what is in the pipeline down the road for <unk>.
<unk> growth there as we pointed out in the comments.
Each of the funds and the SMA as we're in the $404 40 to $4 90 range.
SMA is a little bit ahead.
But I don't think I can.
Give you an accurate thing about where that would go I think history shows that when the worm turns on this it does quite well.
And it's simply because.
The portfolio manager and the team simply do the same thing they've been doing throughout don't forget that franchise was over $30 billion and dropped down to $25 billion and the 25 billion state why because they are consistently paying dividends and buying <unk>.
Companies that they felt had growth of dividend potential.
And guess, what they're going to be doing today tomorrow and the next day exactly the same thing.
So it is very much a portfolio management activity of repeating the sounding joy repeating the sounding joy.
Thanks.
Thank you and there were no other questions in queue at this time I'd like to hand, the call back to Ray Hanley for any closing remarks.
Well. Thank you for joining US today. This concludes our call and we appreciate your interest.
Thank you ladies and gentlemen, this does conclude today's conference you may disconnect. Your lines at this time and have a wonderful day. Thank you for your participation.