Federated Investors filed their latest "10-K Annual Report" with the Securities & Exchange Commission Friday. It says, "Federated Investors, Inc., a Pennsylvania corporation, together with its consolidated subsidiaries (collectively, Federated), is a leading provider of investment management products and related financial services. Federated has been in the investment management business since 1955 and is one of the largest investment managers in the United States (U.S.) with $365.9 billion in assets under management (AUM or managed assets) at December 31, 2016." We excerpt the highlights from the filing below, which provide an interesting look into the business and risks of the money market mutual fund industry.
The report says, "Federated provided investment advisory services to 124 sponsored investment companies and other funds (Federated Funds) as of December 31, 2016. Federated markets these funds to banks, broker/dealers and other financial intermediaries who use them to meet the needs of customers and/or clients (collectively, customers), including retail investors, corporations and retirement plans. The Federated Funds are domiciled in the U.S., with the exception of Federated International Funds Plc and Federated Unit Trust, both of which are domiciled in Ireland, the Federated Cash Management Funds, which are domiciled in the United Kingdom, the Federated Short-Term Daily U.S. Dollar Fund, Ltd., which is domiciled in the Cayman Islands."
It continues, "Of the 124 Federated Funds as of December 31, 2016, Federated's investment advisory subsidiaries managed 38 money market funds totaling $206.4 billion in AUM, 48 fixed-income funds with $39.5 billion in AUM and 38 equity funds with $36.2 billion in AUM. As of December 31, 2016, Federated provided investment advisory services to $83.8 billion in Separate Account assets. These Separate Accounts represent assets of government entities, high-net-worth individuals, pension and other employee benefit plans, corporations, trusts, foundations, endowments, sub-advised mutual funds and other accounts or products owned or sponsored by third parties."
Federated writes, "Throughout 2016, the FOMC deferred making increases in this target rate, but in December raised the federal funds target rate range by an additional 25 basis points to 0.50%-0.75%. The federal funds target rate, which drives short-term interest rates, had been close to zero for nearly seven years prior to the December 2015 increase. As a result of the long-term near-zero interest-rate environment, the gross yield earned by certain money market funds is not sufficient to cover all of the fund's operating expenses. Since the fourth quarter of 2008, Federated has voluntarily waived fees (either through fee waivers, reimbursements or assumptions of expenses) in order for certain money market funds to maintain positive or zero net yields.... These fee waivers have been partially offset by related reductions in distribution expense and net income attributable to noncontrolling interests as a result of Federated's mutual understanding and agreement with third-party intermediaries to share the impact of the Voluntary Yield-related Fee Waivers."
They tell us, "Federated is one of the largest U.S. managers of money market assets, with $252.2 billion in such AUM at December 31, 2016. Federated has developed expertise in managing cash for institutions, which typically have strict requirements for regulatory compliance, relative safety, liquidity and competitive yields. Federated began selling money market fund products to institutions in 1974. Federated also manages retail money market products that are typically distributed through broker/dealers. At December 31, 2016, Federated managed money market assets in the following asset classes: government ($190.3 billion); prime ($46.8 billion); non-U.S. domiciled ($9.3 billion); and tax-free ($5.8 billion)."
The filing adds, "Federated's distribution strategy is to provide products and strategies geared toward financial intermediaries, primarily banks, broker/dealers and investment advisors and directly to institutions such as corporations and government entities. Federated provides comprehensive investment management to more than 8,500 institutions and intermediaries including corporations, government entities, insurance companies, foundations, endowments, banks and broker/dealers. Federated uses its trained sales force of over 200 representatives and managers to add new customer relationships and strengthen and expand existing relationships."
It also says, "Federated's investment products and strategies are distributed in four markets. These markets and the relative percentage of managed assets at December 31, 2016 attributable to such markets are as follows: wealth management and trust (40%); broker/dealer (34%); institutional (22%); and international (4%).... Federated pioneered the concept of providing liquidity management to bank trust departments through money market mutual funds in 1974, and has since expanded its services nationwide to institutional cash management and treasury professionals, as well as financial professionals.... The majority of Federated's managed assets from the wealth management channel are invested in money market funds.... Federated distributes its products and strategies in this market through a large, diversified group of over 1,300 national, regional and independent broker/dealers and bank broker/dealers.... Federated also offers money market mutual funds as cash management products designed for use by its broker/dealer customers."
Federated's 10-K states, "Increased regulation and oversight of the investment management industry in the U.S. continued in 2016. With the commencement of President Trump's administration in 2017.... Despite the regulatory moratorium and possibility for deregulation, additional regulation and oversight of the investment management industry is expected to continue in 2017, albeit possibly to a lesser extent. The increased regulation has required, and is expected to continue to require, additional internal and external resources to be devoted to technology, legal, compliance, operations and other efforts to address regulatory-related matters, and has caused, and may continue to cause, product structure, pricing, offering and development effort adjustments, as well as changes in asset flows and mix, customer relationships, revenues and operating income. The current regulatory environment has affected, and is expected to continue to affect, to varying degrees, Federated's business, results of operations, financial condition and/or cash flows."
It continues, "The implementation of changes stemming from the structural, operational and other requirements imposed pursuant to amendments to Rule 2a-7 under the 1940 Act (Rule 2a-7), and certain other regulations, adopted on July 23, 2014 (2014 Money Fund Rules), and related guidance (collectively, the 2014 Money Fund Rules and Guidance) was completed on or before October 14, 2016, the final compliance date for the 2014 Money Fund Rules. Subsequently, the SEC has announced that compliance with the structural, operational and other requirements imposed under the 2014 Money Fund Rules and Guidance will be an examination priority in 2017.... Given the regulatory moratorium and possibility for deregulation that exist in the current regulatory environment in the U.S., the degree of impact of the 2014 Money Fund Rules and Guidance, Final Fiduciary Rule and Other Regulatory Developments can vary and is uncertain."
Federated explains, "The current regulatory environment, including the SEC's 2014 Money Market Fund Rules and Guidance and the SEC's Final Fiduciary Rule, has impacted, and will continue to impact, Federated's business, results of operations, financial condition and/or cash flows. For example, the floating NAV for institutional and municipal (or tax-exempt) money market funds, and redemption fees and liquidity gates, required from and after October 14, 2016 under the 2014 Money Fund Rules and Guidance resulted in a shift in asset mix from institutional prime and municipal (or tax-exempt) money market funds to stable NAV government money market funds across the investment management industry and at Federated, which impacted its AUM, revenues and operating income. While management believes that, as interest rates rise, money market funds will benefit generally from increased yields, particularly as compared to deposit account alternatives and that, as spreads widen, investors who exited prime money market funds will likely reconsider their investment options over time, including Federated's prime private money market fund and prime collective fund, the degree of improvement to Federated's business can vary and is uncertain."
They add, "Federated has dedicated, and continues to dedicate, significant internal and external resources to analyze and address the 2014 Money Fund Rules and Guidance and the Final Fiduciary Rule, including considering and/or effecting legislation, regulation, product structure and development, information system development, reporting capability, business and other options that have been or may be available in an effort to minimize the potential impact of any adverse consequences. For example, Federated took steps to adjust its money market fund product line to offer a broad menu of institutional, municipal, prime, government, 60-day maximum maturity, 7-day maximum maturity and private and collective money market funds."
They also tell us, "Management believes that the floating NAV, and fees and gates, required by the 2014 Money Fund Rules, as well as the Final Fiduciary Rule and Other Regulatory Developments, will be detrimental to Federated's fund business. In addition to the impact on Federated's AUM, revenues, operating income and other aspects of Federated's business described above, on a cumulative basis, Federated's regulatory, product development and restructuring, and other efforts in response to the 2014 Money Fund Rules and Guidance, Final Fiduciary Rule and Other Regulatory Developments, including the internal and external resources dedicated to such efforts, have had, and may continue to have, a material impact on Federated's expenses and, in turn, financial performance."
Federated also comments on European money fund reforms, writing, "On December 7, 2016, the Committee of Permanent Representatives from Member States approved the initial draft of the EU money market fund reforms. On December 8, 2016, the European Parliament Committee on Economic and Monetary Affairs approved the initial draft of the reforms. Final approval of the reforms by the Council of Ministers and Plenary in the European Parliament is expected later in the first or second quarter of 2017. The final reforms provide for the following types of money market funds in the EU: (1) Government constant NAV (CNAV) funds; (2) Low volatility NAV (LVNAV) funds; (3) Short-term variable NAV (VNAV) funds; and (4) standard VNAV funds.... Unlike government CNAV and LVNAV funds, short-term VNAV and standard VNAV funds will not be subject to discretionary and mandatory redemption gates and/or liquidity fees.... Under the final EU money market fund reforms, sponsor support will be prohibited for all money market funds."
They state, "The EU money market fund reforms are expected to go into force 20 days after the publication of the final reforms in the Official Journal of the EU. The publication of the final reforms is expected to be published late in the second quarter of 2017 after the reforms receive final approval. If the EU money market reforms receive final approval in their current form, the EU money market fund reforms will be effective (i.e., must be complied with) in regards to new funds 12 months after the reforms go into force (or around late in the second quarter of 2018) and will be effective (i.e., must be complied with) in regards to existing funds 18 months after the reforms go into force (or around late in the fourth quarter of 2018). While the reforms will need to be complied with in 2018, government CNAV and LVNAV fund reforms will be subject to a future review by the European Commission in 2022.... [I]t is uncertain whether Brexit could delay implementation of the EU money market fund reforms."
Finally, the comment on "Risk of Federated's Money Market Products' Ability to Maintain a Stable Net Asset Value." The report explains, "Approximately 45% of Federated's total revenue for 2016 was attributable to money market assets. An investment in money market funds is neither insured nor guaranteed by the FDIC or any other government agency. Federated's retail and government money market funds, as well as its private and collective money market funds, seek to maintain a stable NAV.... It is possible for an investor to lose money by investing in these funds. Federated devotes substantial resources, such as significant credit analysis and attention to security valuation in connection with the management of its products and strategies. However, there is no guarantee that a money market fund will be able to preserve a stable NAV in the future.... If the NAV of a Federated stable NAV money market fund were to decline to less than $1.00 per share, such Federated money market fund would likely experience significant redemptions, resulting in reductions in AUM, loss of shareholder confidence and reputational harm, all of which could cause material adverse effects on Federated's business, results of operations, financial condition and/or cash flows. It is also possible that, if an institutional prime or municipal (or tax-exempt) money market fund's fluctuating NAV consistently or significantly declines to less than $1.0000 per share, such Federated money market fund could experience significant redemptions, resulting in reductions in AUM, loss of shareholder confidence and reputational harm, all of which could cause material adverse effects on Federated's business, results of operations, financial condition and/or cash flows."
