Federated Hermes released its Q4'22 earnings and hosted its quarterly earnings call late last week, which discussed record money fund assets and seasonal flows, the end of fee waivers and money funds vs. bank deposits. The press release, entitled, "Federated Hermes, Inc. reports fourth quarter and full-year 2022 earnings," quotes President & CEO J. Christopher Donahue, "Federated Hermes' record assets at year-end 2022 were driven by money market asset increases and investor interest in our flagship Total Return Bond Fund and related separate accounts, as well as continued demand for our popular dividend income equity products. In addition, investors valued our investment perspective as they sought haven from market volatility in a diverse range of Federated Hermes products -- from money market funds to low-duration fixed-income options to market neutral and bear market alternative strategies." (See Federated Hermes' Q4 2022 Earnings Call Transcript from Seeking Alpha.)
The release explains, "Federated Hermes' fixed-income assets were $86.7 billion at Dec. 31, 2022, down $10.9 billion or 11% from $97.6 billion at Dec. 31, 2021 and up $1.3 billion from $85.4 billion at Sept. 30, 2022. Top-selling fixed-income funds on a net basis during Q4 2022 were Federated Hermes Total Return Bond Fund, Federated Hermes Conservative Municipal Microshort Fund, Federated Hermes Institutional High Yield Bond Fund, Federated Hermes Conservative Microshort Fund and Federated Hermes Intermediate Corporate Bond Fund."
It says, "Federated Hermes' money market assets were a record $476.8 billion at Dec. 31, 2022, up $28.9 billion or 6% from $447.9 billion at Dec. 31, 2021 and up $35.5 billion or 8% from $441.3 billion at Sept. 30, 2022. Money market mutual fund assets were $335.9 billion at Dec. 31, 2022, up $23.1 billion or 7% from $312.8 billion at Dec. 31, 2021 and up $26.0 billion or 8% from $309.9 billion at Sept. 30, 2022. Federated Hermes' money market separate account assets were $140.9 billion at Dec. 31, 2022, up $5.8 billion or 4% from $135.1 billion at Dec. 31, 2021 and up $9.5 billion or 7% from $131.4 billion at Sept. 30, 2022."
Federated tells us, "Revenue increased $145.4 million or 11% primarily due to a decrease in voluntary yield-related fee waivers. This increase was partially offset by a decrease in revenue due to lower average equity assets, a decrease in revenue due to a change in the mix of average fixed-income assets, and a decrease in performance fees and carried interest. During 2022, Federated Hermes derived 59% of its revenue from long-term assets (36% from equity assets, 14% from fixed-income assets and 9% from alternative/private markets and multi-asset), 40% from money market assets, and 1% from sources other than managed assets."
They write, "Operating expenses increased by $174.8 million or 19% primarily due to increased distribution expenses resulting primarily from lower voluntary yield-related fee waivers partially offset by a decrease due to lower average managed long-term fund assets and the mix of average money market fund assets. The current year also includes an increase in other expenses due to the intangible asset impairment. These increases were offset by a decrease in compensation and related primarily due to exchange rate fluctuations."
The release adds, "There were no voluntary yield-related fee waivers during the quarter that ended Dec. 31, 2022. For the year that ended Dec. 31, 2022, voluntary yield-related fee waivers totaled $85.3 million. These fee waivers were largely offset by related reductions in distribution expenses of $66.5 million, such that the net negative pre-tax impact to Federated Hermes was $18.8 million for the 12 months ended Dec. 31, 2022. During the three and 12 months ended Dec. 31, 2021, voluntary yield-related fee waivers totaled $110.1 million and $420.3 million, respectively. These fee waivers were largely offset by related reductions in distribution expenses of $72.3 million and $277.1 million, respectively, such that the net negative pre-tax impact to Federated Hermes was $37.8 million and $143.2 million for the three and 12 months ended Dec. 31, 2021, respectively."
On the earnings call, Chris Donahue says about money markets, "The Q4 asset increase reflected seasonality and favorable market conditions for cash as an asset class. Money market strategies are benefiting from higher yields, elevated liquidity levels in the financial system, and favorable yields compared to bank deposits. We expect higher short-term rates will benefit money market funds over time, particularly as compared to deposit rates. Our money market mutual fund market share, including the sub advised funds was about 7.7% at the end of 2022, up from about 7.4% at the end of the third quarter of 2022. Looking now at recent asset totals as of a few days ago, managed assets were approximately $674 billion, including $475 billion in money markets, $90 billion in equities, $85 billion in fixed income, $21 billion in alternative private markets, and $3 billion in multi-asset. Money market mutual fund assets were $325 billion."
CFO Tom Donahue explains, "Total revenue for Q4 decreased $7.2 million or about 2% from the prior quarter due mainly to lower average long-term assets and lower performance fees in carried interest, partially offset by higher average money market assets."
During the Q&A Session, one analyst asked ultrashort and money market flows. Money Market CIO Debbie Cunningham responds, "From an ultrashort perspective, it definitely pertains to where we are from an interest rate standpoint in the marketplace. Interest rates continued to go up in the fourth quarter by 75 basis points and then again 50 basis points in December. The expectation is, they'll continue to go up more modestly, but hold at a higher level in 2023. When you see that sort of increase in rates in the marketplace generally, anything outside of liquidity products -- i.e. money market products or cash -- are going to see flows going in the opposite direction."
She explains, "Those flows can come out of the institutional side, the retail side, corporate. So, there's generally speaking, a broad-based exit that has slowed down as the year has progressed. And in products, even like Micro-shorts that got money in, that basically is offsetting some of what we're seeing [a] little bit further out the yield curve, the ultrashort types of products."
Cunningham continues, "From a money market fund perspective, the mix continues to be obviously predominantly in the government sector. However, where we experienced on a percentage basis, the most amount of growth during 2022 was in the [prime and muni] sectors. That's simply a result of being above zero at this point and therefore the spread between government and those other categories widening out as interest rates themselves have increased."
She adds, "When you look at it on a quarter-over-quarter basis, the fourth quarter always has a huge amount of inflows.... A large amount of inflows in the second half of December, let's call it, it's window dressing, as well as tax purposes, issues.... Ultimately this results in inflows into the government in particular money market funds during the second half of December, some of which then goes out -- generally the first quarter of 2023 sees outflows out of those products. Because of increasing interest rates, however, the other categories prime, in particular, has continued on a percentage basis to offset those flows in a pretty decided way."
Tom Donahue discusses separate account growth, stating, "That category of asset for us is dominated by large state cash pools that we manage. [These have] a regular pattern of increasing when tax receipts are made ... through the middle of the second quarter typically and then that tends to go down over the latter half of the year. But [these have] reached higher highs and higher lows. We've had a lot of underlying success both because of a favorable macro for money market yields and also some effective work that we've done with those clients to increase utilization of those pools."
Finally, when asked about "an expectation of a bigger surge into money fund flows from say deposits, Cunningham answers, "Generally speaking, when interest rates are increasing, because money funds have a weighted average maturity that's something greater than a day, they lag the direct market. For many of our institutional clients that have the capability of going into the direct market, they might do just exactly that rather than go into money market funds that are increasing [with] a one-month lag.... Where money funds generally start to excel and exceed from a growth perspective is when interest rates have, kind of reached a plateau and when they start going back down the other side."
She adds, "Looking at the rates on deposits versus the rates on money market funds ... we're up to about 38% from a deposit beta perspective versus what's happening in ... Fed funds. So, 38% of the increase is being captured in deposits.... I think that the average deposit rate for the fourth quarter was up to about 70 basis points. But compare that to where we are from a fund yield perspective, which is essentially all north of 4% and heading towards 5%.... The expectation would be that we'll continue to fuel outflows with that deposit beta being lower and a very natural recipient of those outflows would be money market funds."
