Federated Investors released its latest earnings report late last week and hosted a conference call on Friday. President & CEO J. Christopher Donahue comments in the release, "Investors also continued to choose money market strategies for liquidity solutions, especially our prime money market products.... Money market assets were $333.1 billion at June 30, 2019, up $77.9 billion or 31% from $255.2 billion at June 30, 2018 and up $14.7 billion or 5% from $318.4 billion at March 31, 2019. Money market fund assets were $231.3 billion at June 30, 2019, up $58.6 billion or 34% from $172.7 billion at June 30, 2018 and up $16.5 billion or 8% from $214.8 billion at March 31, 2019. Federated's money market separate account assets were $101.7 billion at June 30, 2019, up $19.1 billion or 23% from $82.6 billion at June 30, 2018 and down $1.9 billion or 2% from $103.6 billion at March 31, 2019."
The release says, "Revenue increased $65.5 million or 26% primarily due to the consolidation of Hermes' revenue and higher average domestic money market assets. These increases in revenue were partially offset by a decrease in revenue from lower average domestic equity assets.... During Q2 2019, Federated derived 61% of its revenue from long-term assets (42% from equity assets, 14% from fixed-income assets and 5% from multi-asset and alternative/private markets assets), 38% from money market assets, and 1% from sources other than managed assets.... Operating expenses increased $61.3 million or 35% primarily due to the consolidation of Hermes' expenses and an increase in distribution expenses associated with higher average money market fund assets."
On their Q2 2019 Earnings Conference Call, Donahue comments, "Now looking at money markets. These assets increased about $15 billion in the second quarter. We saw positive money market fund flows from a variety of institutional and intermediary clients in the second quarter. Money market strategies continue to have a significant yield advantage compared to average deposit rates. Prime money fund assets increased $8 billion were about 15% in the second quarter. Our money market mutual fund market share including sub-advised funds at the end of the second quarter, increased to just over 8%."
When asked about recent gains, he responds, "Generally when you've been committed to this business as long as we have ... many decades, the customers and the marketplace realized that we are a go-to player in the money market space. And so when the products and the sales force and the story align ... we get back to the thrilling days of yesteryear when our market share was at 8%. And I'll let Debbie comment on a little bit on some of the specifics.
Money Market CIO Deborah Cunningham answers, "Basically I think you have to do with a couple of different things. As Chris mentioned, dedication to this business for nearly 50 years at this point, I think breadth of product-mix. We still have a large group of products to offer in all aspects of our governments money market funds, of our prime money market funds and of our tax-free money market funds both on a national as well as the state-specific basis. So I think we're a one-stop shop for a lot of different options for people to maybe not place their trade with just one specific fund but across several categories."
She continues, "We've also seen a broad selection of both institutional players in the market as well as the traditional ticket trade coming through the retail marketplace. With the ... yield curve ... being slightly inverted at this point ... and the products on a yield basis looking particularly attractive versus what's ... offered from the deposit base, all of those things make the money market fund product mix very attractive at this point. So it's a combination of having a lot of experience in this marketplace, having yields that are very competitive and having a solution for clients and the base of clients that is not just one particular asset, but across all assets of this business in the marketplace."
On Fed cuts, Cunningham states, "So the 25 basis points, I think is pretty much baked in the cake at this point, and then it will depend on how the yield curve looks after that and what the expectations would be for continuing movement. Certainly, what we don't see is the Fed returning rate to the zero-rate environment.... In a decreasing rate environment, even if it's a mildly decreasing rate environment, generally speaking, managed products like money market funds and other, short-term liquidity products look very, very attractive versus the direct market. And as such it's a prime time for gathering assets into this asset class reallocating into this asset class. So we would expect that to continue."
Donahue adds, "Another observation here is this despite whatever the Fed does these are overwhelmingly cash management service products. Yes, they have yield. Yes, they count [as] investments. [But] there is an underlying force that causes people to want to have the money market fund regardless of what the Fed does. And I agree that, once you get down in the 1% and below, [then] you're waiving and you have a slightly different situation.... But in any of these kind of situations, including the new dynamic of them lowering rates and us having a higher yield, historically that has, as Debbie pointed out, been a time for more assets rather than less assets ... coming into the funds."
When asked about the PNC funds merger, Donahue comments, "Well, we're pretty busy working the [PNC] transaction ... that's a pretty significant deal for us in terms of the number of funds, their money market business [was] $9 billion when we announced the deal.... In terms of looking for future deals, we have our team ... continually out there. And I can't have anything that I'm pointing to or anything more to say than other than we are going to be active and that will certainly consider roll-ups, and then other areas that we are lacking in we continue to look around. Like for instance, the SMA Muni business we are not a significant player there and that's one of the areas that we would have interest of finding somebody who is a significant player there."
Cunningham was also asked about ESG issues. She responds, "Certainly, this is an area that we have been focusing on, for the entire year of 2019. As well as the end of 2018 once we began to understand a little bit more about the ESG and the EOS processes from the -- our Hermes brethren. And ultimately, what has been accomplished within the liquidity team at Federated is an integration of the unique aspects of ESG, information and qualifications if you will, into our internal credit process.... Ultimately, we've always taken into consideration, when doing that minimal credit risk analysis, the various aspects of environmental, social and governance aspects when we're talking about the qualitative association of the various issuers that we're using. What ultimately we have to decide then was after taking the new material that we are using on an input basis from the Hermes folks, is how that plays through within our internal ratings scores."
She adds, "For our largest industry, that being financial services and banking, certainly the governance aspect is a very large influence on how we are reviewing the issuers and the credits that we're using. Probably one of the more important items that we had to decide in this integration is how we look at what I'll call non-traditional type of issuers. So, issuers that may be our repurchase agreements that have collateral behind them and counterparties rather than traditional issuances. Another type that we had to look at was credit enhanced issuers, where you may small municipalities or project finance that was a bank that's providing the guarantee.... And then thirdly would be our asset-backed exposure on mostly the prime side of the equation.... All of that had to be worked out. But I'm proud to say and happy to say that at this point, we have worked it out, we've got our own methodology and we are integrating this ESG assessment into our daily credit work that we perform with the input the valuable input and the proprietary input that comes from the Hermes folks in London."
When asked how a Fed cut might impact retail MMF flows, Cunningham states, "So we've actually seen bank deposit products already being lowered. So despite the fact that the Fed hasn't made any move since December of last year, there are banks that have begun their declining rate environment already. So, although banks are ready then to move their deposit rates in an increasing rate environment, they're quickly adjusting usually on a downside. So if the Fed acts, as we would expect them to ... `we still feel that compared to what deposit products are providing ... a nice return that is commensurate with what they're getting from inflationary perspective in the marketplace."
Finally, she tells us, "As such, we'll continue to find their flows being more likely to be placed in a managed product, such as the money market fund rather than a deposit product at this point. It just really continues to make sense for the retail investor, even if we see a 25 basis point decline in July followed by another one later in the year. It's still will allow the retail customer to have some sort of a return on its cash, which is a pleasant ... increase in their income that they've not been experiencing for too long now at this point. I think they will continue to move their assets into the space."
