Federated Hermes, the 6th largest manager of money funds, reported Q4'23 earnings and hosted its Q4'23 earnings call late last week. On the call, President & CEO J. Christopher Donahue, comments, "We had solid asset growth in Q4, ending with record assets under management of $758 billion, driven by record money market assets.... We recently marked 50 years of innovation and successful management of money market funds as we launched the first fund to ever use the term money market on January 16th of 1974. At year-end 2023, we reached record highs for money market fund assets of $406 billion. Money market separate account assets of $154 billion and total money market assets of $560 billion. Total money market assets increased by $83 billion or 17% during 2003 and by $35 billion or 7% in the fourth quarter. Money market strategies continue to benefit from favorable market conditions for cash as an asset class, elevated liquidity levels in the financial system and attractive yields compared to cash management alternatives such as bank deposits and more recently direct investments in money market instruments such as T-bills and commercial paper."
He explains, "In the expected upcoming period of declining short-term rates, we believe that market conditions for money market strategies will continue to be favorable compared to direct market rates and bank deposit rates. Our estimate of money market mutual fund market share, which includes sub-advised funds, was about 7.4% at the end of 2023, up from about 7.3% at the end of the third quarter last year. Now, looking at recent asset totals as of a few days ago, managed assets were approximately $764 billion, including $568 billion in money markets, $78 billion in equities, $95 billion in fixed income, $20 billion in alternative private markets, and $3 billion in multi-asset. Money market mutual fund assets were at $406 billion."
During the Q&A session, an analyst asked about the "outlook and goals for the money market fund and the alternatives business." Donahue answers, "On the money market funds, remember that over 50 years, we have had the strategy of keeping the money funds alive and well, and they work on the basis of higher highs and higher lows over all that time frame. And our dedication to it in terms of arguing with the SEC, dealing with the realities of the marketplace, have been well rewarded. These money market funds into the future will continue to serve as ballast for the ship of FHI, which it has done to date, noting that when there are variations in the marketplace, the money market funds prove the viability of a differentiated franchise for all seasons, and we continue to maintain that."
He continues, "And don't forget that as the money supply is now back up, that is really the engine of monies going into money funds. So we think that it is a permanent good long-term business. And in terms of top goals for various enterprises, the one way to look at the way we internally view growth in various spheres is simply double them all in five years. Now, that's not going to happen on the money funds, but it's certainly what we would establish as the goals for fixed income equity and especially private markets."
When asked about money market funds versus direct money markets (in a falling rate environment), MM CIO Deborah Cunningham responds, "I think what it does mostly is take the direction of flows and increase it more towards the institutional side. [It] doesn't take away the retail side that has certainly been the driver of the flows in 2022 and 2023. But I think it emphasizes more the institutional side.... You've seen what has been over the course of the last 18 months a fairly steep money market yield curve turn into something that's relatively flat from a prime perspective and relatively inverted from two months out on the government side."
She says, "Ultimately, that means that the institutional buyer of cash securities ... is going to go out of the [direct] securities market, where they've been for the last 18 months, and into something that holds onto yield a little bit longer. That would, in most instances, be money market funds. So our outlook is very positive with regard to flows and somewhat of a shift that occurs [from] 2022 and 2023 being mostly retail [to] 2024 being institutionally driven."
Another question asked about savings accounts still paying 10 or 20 bps, retail inertia and "continuing inflows in retail," Cunningham comments, "Let me just start with a little bit of a history lesson. If you go back prior to the financial problems in 2008, deposits at that point were in the little over $8 trillion area. They ran up to something that was close to $20 trillion ... during the zero-rate environment.... So ultimately, deposit products doubled not because of the attractiveness of the yield, but because there really wasn't any yield in the marketplace."
She states, "The concern was from a safety perspective ... retail trades went into deposits in that environment. What you've seen over the course of the last year and a half has been a small reversal of that, which is why I'm not saying that the retail trade is done. Certainly, it's not surprising that with money funds increasing $1.2 trillion in the past year, deposits are decreasing $1 trillion -- those two numbers are equitable."
Cunningham adds, "Having said that, there's still $17 trillion left in deposits out there, many of which, as you note, are in the 10, 20, 30 basis point camp from a payment perspective. So the expectations would be that that trade continues. Certainly, when you look at deposit betas, [banks] have been loath to increase ... rates, but [they] have been very quick to decrease. Now I'm not sure that that will be the case at this point in this scenario, given that they haven't gone up very far to begin with, but ... I think the retail trade has been awakened and it will continue. I think it will be matched basically by the institutional trade in 2024, but certainly will be a factor that continues to contribute to the flows in this market."
Another analyst asks whether expected institutional inflows due to falling rates will be sticky? Cunningham replies, "How sticky? I think very sticky. Ultimately, institutional investors generally have more options than the retail investor does. But once a trend is begun ... in response to what market conditions are, it stays for a while. So in what I'll call flat to inverted or declining rate environment, you're going to see institutional investors in a product that has more duration associated with it."
She tells us, "Now, institutional investors in the zero percent rate environment ultimately became more measured about how their cash was put into play in the market. They created buckets essentially from a cash perspective, operating cash, which is very short-term overnight type needs, then what would be strategic cash and core cash, depending upon transactions and maybe longer-term needs of their firms. Ultimately, in a declining and stable environment, almost all of that cash becomes part of the sort of the money market franchise. It's only when you start to see interest rates start to go back up that it becomes a little bit more transitory in the context of strategic and operating, trying to capture those higher yields for a longer, or the yields for a longer period of time."
Cunningham also says, "So it's ultimately something that, we've kind of seen as a trend in the flows over time and expect it. In the last rising rate environment of '16, '17, and '18, we saw that, and we saw it similarly change on the decline during COVID. But our expectations are that there's nothing really that drives it. There's no different products in the marketplace that would drive different dynamics in this current cycle."
