Federated Investors, the 5th largest manager of money funds, reported 3rd quarter earnings last week and hosted its quarterly earnings call Friday. The company, which generates over 40% of its revenue from money funds, discussed recent money market fund trends, and compared money funds to recent bank deposit and ultra-short ETF flows. (See the press release, "Federated Investors, Inc. Reports Third Quarter 2019 Earnings" and see the Q3 Earnings Call Transcript on Seeking Alpha here.) J. Christopher Donahue, president and chief executive officer, commented in the earnings release, "As the Federal Reserve cut rates twice in the quarter, investors sought Federated's range of ultrashort products and other fixed income strategies, and our liquidity management solutions approached record highs."
On the call, Donahue stated, "Now we turn to money markets. These assets increased about $26 billion in Q3 [to $359.3 billion, $261.2 billion of which were money funds]. We saw positive money market fund flows from a variety of institutional and intermediary clients during the third quarter. Money market strategies continue to have a significant yield advantage compared to average deposit rates. With recent Fed rate cuts, money fund yields also compare favorably to ... direct market rates and to longer duration securities given the relatively flat yield curve. Our money market fund market share including sub advised funds at the end of the third quarter increased to just over 8.4%, up from about 8.1% for the prior quarter and 7.3% for the third quarter of 2018."
CFO Tom Donahue explained, "Total revenue was up about $19 million or 6% from the prior quarter due mainly to $13.6 million of higher money market revenue, primarily from higher average money market assets. And $3.9 million of higher revenue from an additional day in Q3. Performance fees of $1.4 million were recorded in Q3, no performance fees were recorded in Q2. Revenue was up about $32 million or 10% compared to Q3 of last year due mainly to higher money market revenue of $37 million, partially offset by decrease in revenue of $1.7 million related to lower average equity assets."
During the earnings call Q&A, one analyst asked about zero commissions at brokerages and ETFs. Donahue responded, "It strikes us that big large customers such as we have on the cash side are not influenced one way or the other by a $4.95 charge, whether it's there or not. The next point would be that our customers overwhelmingly are looking for daily liquidity at par. And we are simply not aware from our customer base of that kind of a dynamic occurring where the cash that they have with us would be susceptible to moving into a variable asset value ETF. Also note that those ETFs are pricey, they're 100 bucks or 50 bucks which is really setting the stage for allowing a change from the NAV based on bid-ask spreads. And don't forget the trading differences in how those ETFs work ... they [act] more like stocks [with] T+2 [settlement]. `Our customers are more interested in current use and capability of getting their money. So basically I would say that not all pontifications apply to all clients and we haven't seen that dynamic."
Cunningham discussed recent flows on the call, stating, "We continue to see demand across all three categories of our products; this includes Governments, Primes and Munis. On an actual basis, Government probably garnered the most, just given their larger size. But on a percentage basis, primes and munis actually out [performed] the government sector. Having said that, we -- the shareholders in all of these products -- benefited from the volatility in the repo rates during the mid-September time period, and to some degree continuing ... into the fourth quarter, although in a much, much more muted basis."
She explained, "It [the repo spike] certainly was not reflective of any type of credit event, so they were pretty easy conversations to be having with our shareholders who were questioning what, in fact what was happening in the marketplace. What it basically came down to was a supply and demand mismatch, with some regulatory overlay and maybe some operational glitches from the Fed themselves at least initially.... So those are pretty easy stories to have or information to give to underlying shareholders. And the comfortability I think increased to their participation in the marketplace at that point then."
Donahue commented on gaining assets, "You must have the investment performance. You must have the distribution side. You've got to have the products right at the right time. And the way this business has worked on all of those, they don't all work in sync all the time. You don't win every game. And I don't think there's anything missing. There's just the constant effort of doing the blocking and tackling necessary to win.... One other thing I would say that makes us unique is the power of the money funds. Don't forget when we went public in 1998, you were there Bill [Katz]. Our phraseology was a franchise for all seasons. And so these money funds really count in terms of producing revenues and net income at times when other things aren't firing on all cylinders. And therefore, you can keep the other aspects of the business going very strongly. And this is worked out very well for the long haul."
When asked about fee pressures, Donahue answered, "Well, over the long haul perhaps our experience in money market funds is somewhat indicative. Back in the 70s they were differently priced than they are today. And there were always efforts to lower the prices over ... many decades. And our job is to continue to produce the performance [on] the underlying product, tell a story and maintain the efficacy of the business. And in the end, the clients are willing to pay for performance and clients ... the underlying client or the intermediary client ... want to be able to select the best of the best for these types of efforts.... You can always assume in this business that there is always pricing pressure. It is just part of life."
Discussing money funds vs. bank deposits, Cunningham said, "From a bank product perspective, certainly whether you're looking at the institutional side of the market or the retail side of the market makes a difference. But in either case, the money funds, the managed products ... continue to provide a pretty substantial spread versus those direct products in the marketplace, something on the order of 100 to 150 basis points on the retail and probably still something on the order of 15 to 20 bps maybe even larger on the institutional side depending upon the size of the institution."
She also explained, "As for the lag in the marketplace in a declining rate environment, essentially what we have seen initially was a slightly inverted money market yield curve that turned into a fairly flat money market yield curve. That is now back to a positive money market yield curve, which is reflective of both expectations from the Fed's movement in the future, as well as some of the supply and demand dynamics especially in the Treasury market. With more steepening of the yield curve, [we have] the ability we as liquidity managers to purchase ... higher yielding securities out in the 6 to 12 month areas."
Cunningham also said, "I would expect that we will continue to be able to maintain some of the yield in the portfolios, not necessarily entirely reflecting each move that the Fed might make. That's basically what we've seen with that sort of inversion to flattening to slight steepening now that's already occurred.... The 25 basis points probably haven't played out and potentially won't if that type of a yield curve configuration is maintained."
When asked again about disruption by short-term ETFs, Donahue answered, "So I already commented on the potential of ETF disrupting money market funds, which we simply don't see because customers that we deal with want daily liquidity at par. So I'm not going to go through that catalog. I would ask Debbie if she has comments on that."
Cunningham responded, "Well, I mean we certainly have reviewed the competitors in the marketplace that have ETF products. Like many other types of short-term products [including] ultra short funds, they have gathered assets in the ... slightly declining rate environment that we've been in. However, not [to] the same degree [as the] money market fund industry.... So I think to some degree as we go south of 2% on short term rates, the low rate environment will [stay] above zero. But still lower rates cause people to maybe want to look at their cash balances as to what buckets they need to be in -- those are absolutely necessary for daily activity versus those that maybe might be drawn on 6 to 12 months from now. Potentially there you get some stratification as to how your cash is invested, but at this point we're not even really seeing any kind of impediments from an ETF perspective in that regard."
Finally, Donahue added, "Now I think the second part of your question related to the future of cash. I have a lot of confidence that the Fed will protect its province [from] crypto currencies and wants to run the show as they have indicated that they will do. This does not mean that we are not exploring working on all sorts of ideas about the future of cash, of which I'm not going to get into much detail on. But ... I can assure you that things like 7-by-24, round the globe and things like that are being investigated by many in this field. And we will be in the forefront of that as it evolves."
