On Friday, Federated Investors hosted its Q4 2017 Earnings Conference Call (see the Seeking Alpha transcript here), which discussed a number of issues involving money market funds, including asset flows, sweep accounts, repatriation and H.R. 2319. CEO & President Chris Donahue commented, "Total money market assets increased by $21 billion from the third quarter. Separate account money market assets were up nearly $14 billion, reflecting about $6 billion from a new public entity mandate and growth in existing accounts from seasonality and other factors. Money market mutual fund assets grew by nearly $8 billion reflecting seasonality and other factors. Our money market mutual fund market share ... was 7.4%, up slightly from the prior quarter of 7.3%."
He explained, "Prime money fund assets increased about 1% in Q4, up to $28.7 billion. Assets in our Prime Private Liquidity Fund increased over $500 million in Q4. This product and our Prime Collective Fund had about $850 million in combined assets at year-end, up from $600 million at the end of 2016. These products preserve the use of amortized cost accounting and do not have the burden of redemption fees and gate provisions. Taking a look at our most recent asset totals as of January 24, managed assets were approximately $403 billion, including $268 billion in money markets, $70 billion in equities, $65 billion in fixed income. Money market mutual fund assets were at $181 billion, which is about the same as the average so far here in January."
CFO Tom Donahue added, "Total revenue was about the same from the prior quarter. Higher advisory and administrative service fee revenue due to higher average assets was offset by lower other service fee revenue due to lower money market distribution fee revenue. The lower money market distribution fee revenue was offset by related lower distribution expense. Revenue was down 4% compared to Q4 of last year due to the previously discussed change in a customer relationship in January 2017 and lower money market fund assets. These decreases were partially offset by an increase in revenue due to lower money fund yield-related waivers and higher equity and fixed income-related revenues from higher assets. Operating expenses decreased 1% compared to the prior quarter.... The decrease from the prior quarter was due mainly to lower money market distribution expenses related to asset mix changes. The decrease from Q4 2016 was driven by the impact of the customer relationship change and lower money market fund assets, partially offset by higher distribution expense as money market funds' yield-related waivers decreased."
During the Q&A, President Ray Hanley said, "In terms of the revenue ... it's affected by equity and fixed income as well as money markets. So it's the same kind of mix shift that we talked about last quarter. We had lower assets coming from the more retail sweep type of applications, which have higher distribution fee revenue and related distribution fee expenses. And so those two things move proportionally underneath, but again, there are other things in both of those line items."
Money markets CIO Deborah Cunningham explained, "For first quarter, I think we'll probably continue to [see funds'] regular seasonality. It's aided this year though by the fact that the interest rate environment that we're in is no longer at zero. One-percent and 2% type securities in the market for money markets are actually prevalent at this point, and the funds are returning something that is producing income for their clients.... So our expectation is optimistic for what the first quarter will produce."
Responding to a question on flows, Chris Donahue answered, "But what I like is the possibilities of our bill that we have supported, H.R. 2319, which basically says, 'Let's go back to the thrilling days of yesteryear on amortized cost, institutional prime and institutional muni funds,' wherein $1 trillion is left. So there could certainly be a $1 trillion comeback. And when you throw all the money up in the air, that's usually a good thing, especially for those who are in favor of doing this. Why? For the benefit of the clients who have all lost their 30 basis point spread by having to be stuck into a government fund, where they don't get the 30 basis points ... that's associated with a prime fund. So if this thing marches through Congress, this would be a big effort for us."
Cunningham added, "From a theme standpoint, I think what we're looking at for 2018 is the performance of money market funds in a rising rate environment versus deposit products. So deposit products currently stand at over $11 trillion, whereas the money fund industry is slightly under $3 trillion at this point. If you go back to the financial crisis in 2008, both products stood right around $4 trillion at that point. In a rising rate environment, however, because deposit products are administered rates, whereas money funds follow market rates, typically, money market funds perform quite well versus the deposit products. So that's basically where we see a lot of growth coming from."
She continued, "In fact, on a one year basis, if you look at the growth rate in deposits and the growth rate in the fund industry, it's the first year in the last 10 years where the fund industry grew at over 4% and the deposit industry only grew by 3.3%. So not a whole lot of difference, but there was a difference, and we exceeded at that point. So that's our theme for 2018, and we think that there's a lot of cash to move from that specific area."
On which channels may see better growth, Cunningham responded, "Well, it certainly seems as though some of the corporate side of the equation, especially from a repatriation perspective, has a lot of opportunity associated with that cash. Dollars might be flowing back into the United States because of the tax bill.... Also, when you look at some of the sweep products that went into government money market funds, as Chris was mentioning, some portion of that [has] become comfortable again with prime money market funds. Those will likely grow also in 2018. So there's probably not a channel where we feel at all constrained or as if their growth might be stagnant. It's all looking pretty positive at this point."
Cunningham also said, "Going back to sort of the repatriation side, certainly, there's been a lot of announcements by various firms -- Apple, in particular, last week, and some other technology firms, Starbucks. Different ones have announced some, at least, initial plans for where some of ... that cash flow will be placed. We think that will be a substantial area of growth in 2018. And generally speaking, I think winning back clients that, for purposes of, initially, the financial crisis and concern about the fund industry versus the banking industry, went into deposit products, again, will be something that we continue to focus on in 2018 and, we think, has a lot of upside potential associated with it."
She told the call, "From a money market fund standpoint, we do think that the growth that we're anticipating there is substantial. Certainly, it seems as though there are quite a few clients who are dipping their toe back into the prime world, the prime institutional world in particular. We have funds that were decimated in size from a regulatory environment. But at this point -- in the fourth quarter and second half of 2017 -- grew more than 50%. Now it's 50% off of a small base, so it doesn't create the same amount of dollars sometimes as what you might be thinking of in the context of 50% growth. Having said that, that seems to be a swell that's growing. Our expectations would be it will continue in 2018 and probably pick up speed just simply because of the additional return that's ... expected as the Fed continues on its path toward normalization and what I'd say is probably a 2% rate environment."
On sweep accounts and the shift into FDIC products, Cunningham commented, "That is a dynamic that ... has been in play for the last six or seven years. Initially, there was a large movement of sweep products into deposit products. And then, most recently, in the last two years, it's been a movement from prime funds into government funds, mostly having to do with the gates and fees and the concern from a sweep product perspective about those aspects of the prime institutional fund. And again, we're starting to see both of those things reverse. And although there have been some conversions still into the bank deposit market, it's been fewer and far between."
She explained, "And again, we think that rates ultimately will drive that equation. And even from a government money market fund standpoint versus those deposit rates, there's a lot of interest.... The comparison is very good coming in ... with the government money market fund on top.... We've had a handful of customers that have gone back and readdressed the whole gates and fees idea within the sweep product aspect and have gotten comfortable with it and have updated their systems to be able to handle that aspect, even though it's unlikely and remote. And as such, we're beginning to see a very small flow back into [Prime]. We think that will grow as 2018 continues."
Asked if flows would return to Prime if the Stable NAV Bill passes, Donahue responded, "I think it would be more or less a lag, but I wouldn't have used the word substantial. And the reason is that you got to burp out all the new products, and so that's going to take a certain amount of time to get them around. Then the products have to be big enough where the clients can feel comfortable with their normal position. So you're going to have to grow your way back to nirvana where they were before. So that's how I would see it. But it is so clear that the customers, the issuers and the marketplace prefer that product. I mean, that's why they moved $1 trillion from Prime to Govie. So I have a lot of confidence that, that money will come back. As to making book on it, I throw around the idea that once you've been marked up, it's a coin flip. But the thing is you can come up with anything you want as to what is going to happen in Congress, and I'm not going to dispute it with you, argue it with you or come up with a different view."
Cunningham answered a question on seasonality, "Generally speaking, the first half of the year, the first quarter of the year are low in flows and are more on the negative side than on the positive side. Then that completely reverses in the second half of the year and particularly building towards the largest quarter, which is generally the fourth quarter. And again, I think this year the second half of the year will be amplified and probably maybe even bleed into the first half of the year from an uptick perspective, just given where interest rates are at this point. Two percent versus 0% is a heck of a difference, and nobody is real concerned about regulatory reform anymore at this point."
Finally, she added, "Maybe there's some shift in their asset mix that they're looking to make. Maybe they're looking to diversify a little bit where their assets are. But for the most part, those that have assets in the liquidity space, actually, those are likely to grow again. Repatriation [is also] something that we have out there as an unknown, but likely a positive. We'll be trending, we believe, towards the sector that makes the most amount of sense in the current rate environment, which is the money fund side."
