Federated Investors hosted its "Q3 2018 Earnings Conference Call" on Friday, and, as usual, the management team of the 5th largest manager of money market funds weighed in on a number of issues impacting the cash marketplace. Federated CEO and President Chris Donahue commented, "Total money market asset increased approximately $9 billion with funds up $10 billion and separate accounts down about a billion mainly from seasonality. We had positive money market fund flows from a variety of institutional and intermediary clients in the third quarter.... Prime money market fund assets increased about $6 billion or 18% in the third quarter from $32 billion to $38 billion. Our money market mutual fund market share at the end of the quarter was 7.3%, up from Q2's 7.0%."
He continued, "Managed assets were approximately $436 billion, including $269 billion in money market, $79 billion in equity, $65 billion in fixed income, $18.5 billion in alternative, and $4.5 billion in multi-asset. Money market mutual fund assets were $187 billion. In the institutional channel, RFP and related activity continues to be solid with diversified interest in MDT, EAFE, Kauffmann for equities and trade finance, floating rate and short duration for fixed income."
CFO Tom Donahue added, "Total revenue increased by $52.6 million from the prior quarter due mainly to the addition of Hermes revenue which was $49.7, an additional day about $3 million, and higher average money market assets which brought about $1.5 million. Revenue was up $30 million compared to Q3 of last year due mainly to Hermes, partially offset by the impact of the adoption of the revenue recognition standard, about $9 million, higher waivers, primarily from money market funds, about $5 million, and changes in the asset mix of average money market assets also impacted the revenue by about $2 million."
During the call's Q&A session, J.P. Morgan Analyst Ken Worthington asked, "To what extent, if at all, are you seeing a movement back to funds from bank balance sheets?" Money Market CIO Debbie Cunningham answered, "We are definitely seeing a movement back into money market funds. Our assets are higher; the industry's assets are higher. And I think this is probably reflective of both investors getting comfortable with the regulatory changes that went through in 2016 ... but in addition just higher interest rates in general.... On the retail side [it's] more ticket trades that are new business, presumably coming out of some sort of a bank product or some other type of liquidity product and going in to the prime products."
She said, "From a sweep perspective, there is still not much on the retail side that is set up with prime products. There are a few intermediaries that are able to do that, but for the most part sweep products continue to be through government funds. And prime products are generally on the retail side generating business from a ticket trade perspective. On the Muni side also, we are seeing quite a few flows on the retail side.... The industry itself is fairly flat on the Muni side. [But] we are actually experiencing quite healthy flows in our municipal products, both the national as well as the state-specific."
Cunningham added, "Switching to institutional, we're seeing in our government funds a lot of growth that came basically in chunks from what would be M&A activity. There's been a huge amount of M&A activity that's taken place year-to-date, 2018. Also, from a repatriation trade perspective much of that cash, which is again chunky, goes into the government funds mainly because it doesn't stay there for too, too long. It goes back out again once either the deal closes on the M&A side or the intended use of the repatriated funds are then put in to their final form.... So definitely, we're seeing an uptick in flows, and it doesn't seem to be between sectors, but rather coming from outside sectors. I think post money market reform the assets in the industry were about $2.6 trillion. We're now just under $3 trillion."
Chris Donahue also stated, "If you were to ask -- and this would be an impressionistic number, if you were to ask the sales individuals here who have those relationships on the broker dealer side for those broker dealer sweeps, they would contend that $20 billion has moved out, or some number like that." Analyst Brian Bedell added, "I mean we're seeing this in the online brokers where clients are moving to purchase money market funds, say, for example, from the bank sweep. So [I'm] trying to see what your future opportunity is from that dynamic given that -- and obviously the yield are very competitive with your funds."
Another question, from Robert Lee with KBW, asked about the "money fund business [being an] increasingly a technology driven business." Donahue answered, "We believe that we have the technology to be able to service these clients as well as anybody in the world.... We try to characterize the whole business as a technology business in order to try and get the PE up so that you would see this was technology business.... But what the clients see is the investment management expertise and the need for the underlying product."
He also commented, "And the one other thing that I would add on this bigger picture score is that we and many, many others including issuers in the marketplace have been working on Senate bill S.1117, which basically restores money market funds in the prime area and in the Muni area to $1 net asset value. And this would be a great boon to the marketplace to restore the pricing that the capital markets have on exactly these products right at that point of the short-term area of the curve. And we're still working on this. Others in the industry seem to not be as enthusiastic about this."
Cunningham also said, "If you look at sort of just from a history lesson standpoint when the financial crisis happened back in 2008, at that point in time, deposit products and money market mutual funds were both around $4 trillion. And since that time because of deposit insurance, because of the zero interest rate environment, because of the concerns in the marketplace, money fund assets, you know, went down to $2.6 trillion. They're now about $3 trillion and deposits soared to you know, depending upon what deposits you're looking at anywhere between $10 trillion and $13 trillion."
She explained, "The fact is though that those assets have stagnated in the context of their growth. They're growing 2%-ish on a annual basis and that's compared to more like double-digits, just barely double-digit growth, 10%-ish type growth in the money market mutual fund marketplace. I think, you know, there were moves that were made by the broker dealer clients that we've talked about that make it a more difficult task to reverse. Nonetheless, I think economics win out and with a continuing rising rate environment, which we would expect you to see in 2019, we don't see any reason why the product should lose its momentum."
Cunningham also stated, "Does it get prime back to the peak of $1.7 trillion? Probably not, at least not in the immediate future. Maybe with Senate bill S.1117, it does. Time will tell on that one. But certainly -- because of technology, because of investment expertise, because of client-driven relationships and the ... provision of information that we provide to them on a pretty easy basis, instantaneously, we have a very positive outlook for the future."
Finally, when asked about fee competition, Cunningham responded, "I think part of the government fund fee discussion had to do with a point in time when there was a lot of asset gathering occurring into that sector. Not necessarily from an industry standpoint, but into that sector. So switching out of Prime and Muni and into government from a sector perspective, the trillion dollars have moved in 2016. There were fee waivers that were done to capture market share at that point and I won't say that it set a new standard, certainly, once the movement occurred, fees began to normalize, although not back to the pre-financial -- pre-reform levels." (See also the Pittsburgh Post-Gazette's, "Higher interest rates? Federated Investors sure hopes so.")
