Federated Hermes hosted its latest quarterly earnings call on Friday (see the Seeking Alpha transcript here), and fee waivers, near zero rates and pending regulatory reforms were again major topics of discussion. CEO & President Chris Donahue comments, "Moving to money markets, assets were up nearly $11 billion in the second quarter with just under half from funds and the rest from separate accounts. Our money market mutual fund of market share, which includes our sub-advised funds, was about 7.4% at the end of the second quarter, up slightly from the first quarter percentage.... [W]e believe that Q2 was the high-water mark for money market fund yield waiver impact. As we expected, the Fed raised the administered rates in mid-June, moving repo rates from zero to 5 basis points and interest on excess reserves from 10 to 15 basis points."
He explains, "While the Fed movement was a step in the right direction, the money fund yield curve remains very flat, and we are experiencing more waivers for competitive purposes. Tom will update our yield waiver outlook for the third quarter. Taking a look now at recent asset totals, managed assets were approximately $638 billion, including $421 billion in money markets, $99 billion in equities, $93 billion in fixed income, $21 billion in alternative, and $4 billion in multi-asset. Money market mutual fund assets were at $293 billion."
CFO Tom Donahue tells us, "Total revenue for the quarter was down from the prior quarter due mainly to the impact of higher minimum yield and competitive waivers.... Now other revenue increases from Q1 included the impact of higher money market assets, increasing revenue by $5 million an additional day, increasing revenue by about $5 million and higher equity and fixed income assets increasing revenue by $3.4 million.... The decrease in distribution expense of $6.3 million, compared to the prior quarter was mainly due to the impact of minimum yield waivers, partially offset by higher distribution expense incurred for competitive purposes."
He continues, "The negative impact on operating income from minimum yield waivers on money market mutual funds is currently estimated to be about $38 million for Q3, down from $46.8 million in Q2. The Q2 waivers were slightly higher than expected due mainly to related higher asset levels. The Q3 estimate is based on our investment team's expectations for portfolio yields and our recent asset levels and mix. The amount of minimum yield waivers and the impact on operating income will vary based on several factors, including, among others, interest rates, the capacity of distributors to absorb waivers, asset levels and asset mix."
During the Q&A session, Federated was asked, "Why the increase in competitive fee waivers?" Chris Donahue responds, "With competitive fee waivers ... it is forever a constant situation. [W]e cannot predict or figure out why certain competitors decide to do certain things over a certain period of time. There are a lot of variables in the equation. Some competitors want to increase their footprints. Others have creative uses of how things work inside their funds. We just try to do the best we can to stay competitive, and so it is not a predictable.... [I]t's not possible for us to [understand] why they're doing certain things on the pricing. So that's the way it is. I do not recall competitive waivers being altered that much in the post 2008 time frame."
MM CIO Debbie Cunningham adds, "The mix of assets so much more is in government funds at this point, compared to the 2008 time frame where more than half of our assets were in prime funds. And the prime funds obviously maintain a higher yield. So the waivers are less. Now that you've got 80% of the industry in government funds with a curve on the government side that is five to six basis points, that's, I think, where some of the positioning and changes have occurred."
When asked about their money fund mix, Cunningham responds, "Well, we have seen more from a 2a-7 money market fund standpoint. More of the inflows have come into the government funds, and that has a whole lot to do with where net yields are right now. Most net yields are to one to three basis point level and to many investors who are comfortable and have been in prime funds, it doesn't really make a whole lot of sense because they're not getting any extra incremental income from a net yield perspective.... So, we've seen our prime money fund, 2a-7 money fund assets decline."
She also says, "Where we've seen increases in the prime side, however, has come in the non-2a-7 business. So, offshore separate accounts, local government investment pools, they seem to be trending more toward the prime space. And the mix of assets on an overall liquidity business basis has remained fairly steady. But with a larger proportion of governments in the 2a-7 space and a larger proportion of prime in the non-2a-7 space."
Chris Donahue adds, "As things have changed over 4-plus decades in money funds, we don't lose clients. They may move from over this type of product to another type of product, or another solution, whether it's a private solution, whatever. Even when the massive amounts of prime were shut down because of the '14 amendments implemented in '16, the clients moved over to our govie funds. Part of the reason for that is our heritage and devotion to the business, our defense of the stakeholders here, but also because ... these clients are diversified.... They do not put all their money with one purveyor. They move it around and keep it diversified and that of course is helpful to us."
Asked about ESG, Donahue states, "When we did the reverse transformational deal with Hermes, we wanted to integrate all of our investment management with ESG, so that you get ESG baked in the cake. [The first] to get that accomplished was the money market funds." Cunningham adds, "Given the high-quality, short-term security types that we use in the money funds, what we basically did was add an additional layer of input into our credit process. So our team management approach for money market funds consists of team members that are investment analysts, portfolio managers and traders. So through our investment analyst positions, we added the ... ESG informational content that was provided, both by external as well as more importantly, internal sources and are using that actively in our assessment for the credit securities that we're using within our portfolio."
She continues, "Our prime funds were the first ones to be integrated just simply because their large use of international global banks and industrial types of firms and the coverage of those types of issuers by the ESG assessors and analysts. But most recently, we've made a lot of progress integrating our government funds, as well with the beginning of engagement strategies with all of various GSEs that we use within our portfolios for the government funds, FHLBs, Fannie Mae, Freddie Mac, the Farm Credit system.... In addition, because many of our municipal funds also rely on the banking system for their letters of credit and guarantors, those have also been fully integrated. So, our level is very high and our amount of input, given the high-quality short-term issuers that we use in these portfolios, has been very impactful and substantive."
Donahue adds, "So ... the answer you should detect from that without mentioning any particular competitor is that, when you're dealing with a Federated Hermes Money Market fund, the word Hermes basically embeds ESG in the process. And when you look at our money market funds, it's designed to go for minimal credit risk. Anytime you see risk somewhere, you want to evaluate it for your purposes. And that's what we're doing here. So, we view our products as fully integrated on ESG and able to stand up against anybody on that score."
Asked about MMF reforms, the Federated CEO says, "The list of things is, as you say, a rehash. I consider a whole lot of zombies coming back from the dead, because most of them are just different forms of killing money funds or killing prime money funds or killing muni money funds. And if that's what they want to do, then they've got to be straightforward about doing it. So, I'm not aware of anything [likely to pass] other than removing the mistake that was made by linking the 30% weekly liquidity with the threat of fees and gates, which did compromise the resiliency of funds."
He explains, "But part of the issue really here is that the Fed, from the mid-'70s, has wanted to eliminate these money funds, and uses any opportunity to do so. We make the argument that the money fund is simply a transparent collection device, a de facto operating entity of bank paper and commercial paper. Don't forget the Fed in 1913 was started in order to help and assist the commercial paper market. So when the Fed takes an action [they] lose no money, take no risk, and do their liquidity deals."
Donahue tells us, "So, we look at the whole thing as the only structural vulnerability that was created, was really the link of the 30%. We also think that the Fed could do a lot more and certainly ought to, before they go about shooting money funds. For example, doing [an] all [to] all-type market where people can really trade these short-term securities. And there are things they can do related to leaving the discount window open, reevaluating SLR in a crisis, and things like that to make the liquidity work smoother and still do everything totally consistent with Dodd-Frank, where all you do is help liquidity and don't help individual people."
Finally, Cunningham adds, "In addition to what Chris was saying about the Fed, we do think one of the things that they did at their meeting this week where they announced the standing repo facility, takes away some of the emergency actions they need to do. So, this replaces their temporary market open market operations.... This standing repo facility, it's the opposite of the standing reverse repo facility that they have. It's therefore borrowing not investing. So, people putting transactions back to them, putting collateral back to them, rather than them taking the cap and giving the collateral. But in fact we think maybe that is a sign of their willingness to look at facilities that are more permanent in nature and able to help in a crisis, rather than just coming up with emergency lending facilities, when they are on the brink of problems."
