Federated Investors released its Second Quarter Earnings late last week and hosted its latest quarterly earnings call on Friday. (See the Seeking Alpha transcript here.) The release says, "Money market assets were $242.1 billion at June 30, 2017, down $12.9 billion or 5 percent from $255.0 billion at June 30, 2016 and down $3.1 billion or 1 percent from $245.2 billion at March 31, 2017. Money market fund assets were $173.3 billion at June 30, 2017, down $44.8 billion or 21 percent from $218.1 billion at June 30, 2016 and down $1.9 billion or 1 percent from $175.2 billion at March 31, 2017. Since June 30, 2016 approximately $25 billion in money market assets has transitioned from Federated funds to Federated separate accounts. Federated's money market separate account assets were $68.8 billion at June 30, 2017, up $31.9 billion or 86 percent from $36.9 billion at June 30, 2016 and down $1.2 billion or 2 percent from $70.0 billion at March 31, 2017."
Federated President & CEO Christopher Donahue comments, "Total assets and funds and separate accounts decreased by $3 billion from Q1. Money market mutual fund assets decreased by about $2 billion from Q1 and separate accounts were down $1 billion, both reflecting seasonality around taxes. Our money market mutual fund of market share, which includes our sub advised funds at the end of the second quarter was 7.4% compared to the prior quarter of 7.5%. While money fund assets remain concentrated in government funds, we did see a slight uptick in prime money fund assets in the second quarter."
He explains, "We believe investors will begin to reconsider their options over time, including our newer private prime fund and collective prime fund, which preserve the use of amortized cost accounting and do not have the burden of redemption fees and gates. We also believe that a rising rate environment will be positive for money market funds and will encourage investors to shift cash from bank deposits. And looking at our most recent asset totals as of July 26, managed assets were approximately $356 billion, including $238 billion in money markets, $66 billion in equity and $52 billion in fixed income. Money market mutual fund assets were at $169 billion on that date and have averaged $171 billion so far in July."
CFO Thomas Donahue comments, "Revenue was down 5% compared to Q2 of last year, due to lower money market related revenues from lower assets and from the previously discussed change in a customer relationship, which occurred near the end of January. These decreases were partially offset by an increase in revenue due to lower money fund yield-related waivers and higher equity in fixed income related revenues. Revenue was down slightly from the prior quarter reflecting a full quarter of the customer relationship change and lower money market assets, offset by decrease in money fund yield-related waivers and an additional day in the quarter and higher revenue from equity assets."
He tells us, "Operating expenses decreased 5% compared to Q2 of last year and decreased 4% from the prior quarter. The decrease from Q2 of 2016 was driven by lower money market assets and the impact of the customer relationship change, partially offset by higher distribution expense as money fund yield-related waivers decreased. As we noted last quarter, the Q2 impact of money funds yield-related waivers was immaterial based on current and expected yields, we expect the impact of the waivers on pretax income going forward to remain immaterial."
During the Q&A, one analyst asked about "the pricing of money market funds" and competitive fee waivers. Thomas Donahue responded, "Overall, I don't think it's any more intense than it has been before. People take turns doing it, and one firm will do it for a while, then another firm will do it for a while. Some will stick to it longer. And we haven't seen ourselves lose any clients over this timeframe. We have seen the assets more or less level off. I think the decrease from during that quarter is the usual seasonality. And recall that ... clients like to diversify among the various people that are actually active in this field. That supplies a pretty good bottom for someone with our strategy and the strong relationships we have with the clients."
He says, "There's also another thing we're working on, I've mentioned it here before, and that is HR 2319, which is a bill floating through Congress. You can put whatever percentage chance you want on a bill coming out of Congress. But this is a bill which would basically restore money market funds to the 2010 amendments, i.e. restore prime funds with amortized cost, no fees and gages, and no natural person, which would enable the municipal funds to regain their once $500 billion that they had."
He adds, "And so that's another strategic way of getting at the same kind of question that you are looking at. Overall, in the money market fund area, the assets remain about the same as where they've been. Yeah, they go up and down a little bit, but you've still got $2.7 trillion in that area. And so what that tells you is that the clients love the utility of the product. Yes, $1 trillion plus moved over to government, but it moved over into a vehicle that retain the utility that was love so much by these clients."
Christopher Donahue adds, "The first thing would be that, as rates increase, it was a big event to get all of the funds more or less ... above 100 basis points. Now ... one of the questions is, 'How big does a spread have to be in order to move people?' We don't think there's going to be a rate increase until December in any event, and then there will be one, so you can tell what that's going to do to the rates in fact."
He states, "So the slow inexorable increase in rates will have a positive impact on this business. But it's very difficult for us to detect when people will switch back to prime if they don't have the utility of the product they want as against the given spread. Right now that spread is about 29 basis points or 30 basis points, and [historically] it used to be 12 basis points to 15 points. People aren't moving back, and I think the reason is the utility of the product. Will it get higher? Will they move? Will they get more comfortable over time with the existing product structure? That remains to be seen."
Deborah Cunningham comments, "I agree 100% that 30 basis points seems like a lot ... more than double what history has shown ... between prime and government. But that's when the two had a profile that were the same from a user shift standpoint and that's different now. So, if 30 basis points isn't enough, maybe it's 40 basis points? But what I really think is happening and what we're getting from a client feedback perspective on a day to day basis, is that they're putting a tiny bit of their cash in prime right now."
She adds, "So they used to have all of their cash in the prime sector. Now they've got, let's say, 80% in the government sector, with 20% ... of new cash ... going into the prime sector, because it is higher spread [and] it's not seeing much volatility. We're not getting the seasonal flows in and out of prime that have historically been larger than what we would see in our government funds instead that day to day cash that needed on a on a daily operational basis is staying in the government space."
Cunningham tells us, "I think the other place where we're starting to gain assets and certainly starting to gain a lot of interest specifically into the prime space is out of the bank deposit market. In a rising rate environment, which as Chris mentioned, we do believe will continue although with a slightly slower speed, we do think that the money funds make a whole lot more sense versus bank deposits that are kind of sticky.... When you look at the average deposit rates [vs.] both government and prime money market funds, {MMFs] are above them substantially now.... So I think it's again taking time. People have to have to get used to this product. But there are various reasons why it looks awfully attractive versus both the traditional government money fund product as well as other cash vehicles that are out there."
On why flows into Prime aren't stronger, Cunningham says, "I think the lot of it has to do with the 5'o clock timing. With the floating net asset value, mark-to-market pricing that occurred, all funds basically ... cutoff ... at 3'o clock. With many institutional clients, they need capacity to transact out at 5 o'clock. So I believe that a good reason why a portion of them are key thing a substantial amount of their cash in that government space."
Christopher Donahue adds, "One of the other [factors] is: are going to test this? They want to make absolutely sure that everything works. How does the four decimal places work? How do the other customers in the fund work? It's really hard to crawl in behind their brain to it figure out ... when are they going to break loose from their test mode into their all-in mode? Well, they are to some modest, modest extent, but you can feel them struggling with their desire to get it and being conflicted by the lack of the utility in the way the products are constructed as against the government fund."
Finally, Cunningham adds, "I think one other fact to consider is the size of the prime fund at this point. The prime funds universe at its peak from an industry perspective was about $1.9 trillion, and there were I say at least 20 products that were over $10 billion to $20 billion in size. There are currently three in the market that are of that size. So, what used to be anything an easy trade for somebody a corporate treasure that had short term cast to say what $1 billion in a single fund, now can't be done in a single fund. It has to be broken up into smaller and net several funds because of the smaller nature of those products."
