Federated Hermes President & CEO J. Christopher Donahue spoke at the 2022 RBC Capital Markets Global Financials Conference two weeks ago (prior to the Fed's 1/4-point rate hike), and discussed fee waivers, money fund asset growth and a number of other topics. We quote from this webinar below. (Note: Registered attendees to our upcoming Bond Fund Symposium conference, which takes place March 28-29 in Newport Beach, Calif, and Crane Data clients may access the latest BFS materials (and recordings afterwards) via our "Bond Fund Symposium 2022 Download Center." See you in California next week!)
RBC Capital Markets' host Kenneth Lee comments, "The negative impact from minimum yield fee waivers are expected to decline rapidly over the next few quarters.... What would you highlight as factors that could impact guidance either to the upside or to the downside?" Donahue responds, "Okay, let's just review from the earnings call what we said about the negative impact on operating income from minimum yield waivers. In the fourth quarter, it was about $38 million. We expected Q1 to improve about to $22 million. Then if you have the 25-basis point rate increase here next week [which happened] ... we would expect in Q2 to go down about 90% or improve by 90% of the $22 million, basically almost wiping it out. Of course, these expectations are based on 100 things ... yields, asset levels, war and peace, ... and every other factor known to man."
He continues, "Powell said last week he wants 25, which our CIO has been saying for a long time.... So, we're thinking they're going to do twenty-five, and other rates have moved up into in anticipation of that. If you look at the 3-month T-bill that averaged about 5 bps in the fourth quarter. Now they're in the mid-30s [bps]. And if you look at the 6-month bills, they averaged 6 bps, now they're up to around 70 bps. That repo rate won't move until the Fed moves. And that's what goes on."
Donahue tells the RBC event, "So then as to the future, what we like, we like ... the 25s.... The first 25 [hike] basically wipes out the majority of the waivers. But it also enables a money market fund to catch up to spot rate faster than 50 or even higher increase. And we believe that they are going to be on track to do the 25s. How many of them? [At least] four to six. It all depends on who you're talking to. Changing that would change [how] some of the interest rates [shift]. But once we get the first increase, we're good to go in terms of the operating income."
Lee also says to Donahue, "Talk about your outlook for money market fund, AUM [asset] growth this year." The Federated CEO replies, "Well, it is rising rates that drives the truck. But there are other factors too. For example, a total risk off scenario in the marketplace due to exogenous, black swan events, such as are going on over in Ukraine could cause people to want to get back into money funds. But I think to have this discussion, we've got to look at the money markets overall the way we look at it our liquidity business. This includes both funds and separate accounts, and they were about $435 billion recently, compared to $448 billion at the start of the year. OK, that's down $13 billion. What happened? The ... money market funds were down about $20B and the separate accounts increased by about $8B. That's what gives us the $13B."
Donahue comments, "So, you can see that that's being led down by the money funds. However, that basically just recaptures some seasonality and some activities on the money funds that occurred at the end of the year.... But what we think this really does is set the stage for increasing assets in up environments after a little time. Our history is that when there's rising rates, we do better on the AUM side. That is in large part because it's a cash management service that's paying the investor more. But it's also ... because the banks are managing their rates, and we’re paying a market rate. They tend to manage their deposit betas so they have profitability, and we have no choice but to pay the market rate -- that's the way it works."
He explains, "One other thing that I'd like to mention is that the overall liquidity levels in the whole system have been enhanced, both by the Fed in terms of QE and [increasing] the money supply, and in terms of COVID response. All that jazz increases the amount of liquidity in the system, and the money market fund is just a percentage of the total liquidity in the system."
Donahue adds, "This has given us new opportunities in terms of talking to clients and coming up with solutions. We do a lot of portfolio construction work on the long side. But we find that there's a great interest among clients and solutions on the short side where people are really concerned about how short they are going to go with one- or two-year period and how do they manage that. What's their portfolio construction look like on the short side? So, we obviously have the money funds, the micro-short, the ultra-short, the short-intermediate and our low-duration products, and we've been pretty good at coming up with answers, solutions and higher-quality type discussions with clients on these matters. So, basically if you talk to the salespeople or guys like me, we think assets will be up by year end."
When asked about "the competitive dynamics to unfold between money market funds and competing bank deposits," Donahue answers, "Well, what is said is the banks don't want them ... however we don't have a lot of evidence they actually turn the deposits away. So, what's going on? They're pricing them for profitability. And so therefore, even though the bank deposits tend to go up at various times, we tend to have a great rate advantage over them, especially if rates increase. And if you look at the last few cycles ... it's been pretty, pretty dramatic, which lights up the beauty of the cash management service called the money market fund."
Finally, he states, "Another thing that goes on is the extent to which the banks say they don't and really don't want the deposits because of capital issues and other things. They will use the money fund, a lot like squishing a balloon. So, this ... allows [excess cash] to go into a money fund, and then if they want it back on the balance sheet, that is good. This has been going on since I was selling mutual money market funds to bank trust departments in the '70s, which is the Stone Age, but it's the same act all over again."
