Federated Investors' CEO Chris Donahue talked about money market fund reform -- and the potential opportunities going forward -- at Barclays Global Financial Services Conference on Monday in New York City. He discussed how Federated and other public commenters helped make the reforms better, new products they are developing, growth opportunities in the money fund space, and plans for future acquisitions. In his 40 minute address, available for replay on Federated's website, Donahue said money funds at Federated have accounted for, on average, 38% percent of revenues, reaching a high of 58% in the second quarter of 2009 and a current low of 26% at present. Of Federated's $352 billion in total assets under management, $245 billion are in money market fund assets. About $114 billion are in government funds, $80 billion are in prime funds, $16 billion are in tax-free funds, and $33 billion are in separate accounts.
Said Donahue, "One of the things we've learned over the years is that the clients are convinced and have convinced the marketplace that they want the daily cash management service that is offered inside a money fund, which is to say, daily liquidity at par. And even though they may have various concerns at various times about yield or price, it is overwhelmingly driven by the demands for the service of dollar in and dollar out."
He spent the bulk of his speech talking about the SEC money fund reforms. "The first thing that happened from our perspective is that our franchise was preserved. If you remember back in the FSOC days, they had launched a missive that indicated that they wanted to kill all money funds in three different ways. I had articulated that it was death by poison, death by bullet, and death by hanging. We have been told by various government officials that what has been done is not killing us, but simply waterboarding us. And if you think about waterboarding, though an unpleasant experience, debate whether you think its torture or not, it eventually ends, so that's about the stage that we are in right now."
On Federated's leadership, he said: "We have maintained a leadership role throughout this, because, I have 8 children and I was never willing to sacrifice one of them to try and preserve the others. So we were not in a position of willing to throw our institutional prime clients under the bus in order to save the other clients; alas, we did not succeed in that venture. But our leadership role continued. We were able to dramatically, I think, improve the result because the SEC ran a very thorough process that incorporated a lot of the comments that were made from the marketplace."
Donahue continued, "We were quoted 250 times inside the SEC release. We were able to preserve the existence of amortized cost in those funds that are retail and those funds that are government. We were able to accomplish something even better than that, which is a long time frame in which to analyze and come up with other products and responses to the rule -- two years. Now mind you, as we stand here today, the two years has not started. The 2 years begins 60 days after the entire rule is published in the Federal Register . So the 2 years begins October 14 and runs until October 14, 2016. This is good because it keeps clients cool. Now they can understand, they can be curious, but they are not doing anything untoward in the marketplace. We also think we have improved the concept of gating built into the funds, [and] we don't think [it] will get used that much if at all."
He talked about how Federated intends to remain a major player in the space. "We look at it next as an opportunity. Yes, there will be some consolidation. There are some 80 firms offering money funds today -- that's down from over 200 before 2008. We think it will continue to whittle down as every time another gang of regulations comes out, more people throw in the towel. The liquidity coverage ratios that have just been published for banks will have an effect on the banks' bidding the money out of money funds. Over the last several years, the bank deposit numbers have gone up much more than the money market funds. So even though the MMFs have stayed level with the assets they've had -- around 2.6 or 2.7 trillion, bank deposits have climbed smartly. Now those banks are going to have to analyze the costs of that money and whether they want to bid it in or not. We think there are going to be opportunities over the long term for more cash management for Federated."
He also talked about new product opportunities. "The other opportunities are going to be in response to the rule and what kind of products and new ideas you come up with... We are going to create private funds for qualified investors. That means you have to have $25M of investable assets.... You would only go there if you are not qualified to stay in the regular retail prime fund. We may, in a different interest rate environment where rates are higher, come up with a 60 day and under fund because a 60 day and under fund can basically stay at amortized cost [if it buys] no instrument longer than 60 days. But you have to have more of a yield than you have today to make that a viable product. We'll also be offering separate accounts, where a large customer can come into that type of account. Then you have the obvious answer of switching people into government funds. Though they take a sacrifice in yield, they retain the daily liquidity at par feature."
He also spoke about the definition of retail. "Now forget whatever you think about retail and institutional, those words don’t count anymore. The only words that count are what the SEC's definition of retail is related to a natural person. So there will be no 'unnatural' persons in any money market fund from now on. Furthermore they said a natural person was someone that eventually you could find had a social security number. Our market share in terms of money funds since the rules came out has remained just about flat at 8.2%. The industry hasn't lost a bunch of assets either. As I said, everyone is staying cool."
Donahue spoke about prime institutional, floating NAV, and the focus going forward. "We have $80 billion in prime.... Of that $80 billion, 42% of it is in wealth management. We think the lion's share of that is going to be qualified as retail because there is a going to be a natural person or a social security number behind the substantial majority of that money. In broker-dealer, we have $21 billion worth of prime and we think almost all of that is going to qualify as retail.... Next we have $10 billion in institutional. Of that $10 billion, we don't know the answer to this yet. But a number of them are qualified to go into these private funds."
He adds, "We are certain, a number will go into government funds, and there may even be some that can re-characterize themselves and turn up as retail. So we're working hard on all of these items -- the definition of retail, working it through with the customers in order to get to the goal of being able to satisfy the SEC rule.... My own belief is there will not be much market place need for a floating NAV money market fund that's being created. We are going to spend the vast majority of our time and effort on product development and looking at improving our funds to have them be retail, coming up with the private funds I mentioned, looking at separate accounts, and going down those roads."
Finally, Donahue says, "I believe as we look at our franchise out a couple of years, we will be back on to growing this franchise and having higher highs and higher lows as the regular cycle of money market funds has done for us over the 40 years that we have been in this business.... In terms of rollups [acquisitions], we are continuing to work on other rollups. I mentioned that there were probably more coming on the money market fund side." Note: The Pittsburgh Tribune-Review also covered the speech in its article, "Federated CEO Says Investment Manager Won't Give Up Money Market Fund Business."
