Federated Hermes, the 6th largest manager of money funds, reported Q2'23 earnings Thursday night and hosted its latest earnings conference call on Friday morning. President & CEO J. Christopher Donahue comments in their press release, "In the second quarter, Federated Hermes benefited from a breadth of investment offerings and robust client relationships, as record assets under management were again driven by money market asset increases from the prior quarter." The release says, "Money market assets were a record $509.0 billion at June 30, 2023, up $69.3 billion or 16% from $439.7 billion at June 30, 2022 and up $3.2 billion or 1% from $505.8 billion at March 31, 2023. Money market fund assets were a record $364.0 billion at June 30, 2023, up $66.0 billion or 22% from $298.0 billion at June 30, 2022 and up $6.7 billion or 2% from $357.3 billion at March 31, 2023." (See the Seeking Alpha earnings call transcription here.) (Note: Click here to see the replay of our recent Money Fund Wisdom Demo & Training, and register soon and make hotel reservations ASAP for our European Money Fund Symposium, which is Sept. 25-26, 2024 in Edinburgh.)
On the call, Donahue says, "We reached record highs for money market fund assets of $364 billion and total money market assets of $509 billion. The second quarter presented a challenging environment for managing money market strategies as the debt ceiling prices significantly impacted short-term debt markets. Despite this challenge, money market strategies continue to benefit from favorable market conditions for cash as an asset class, higher yields, elevated liquidity levels in the financial system and favorable yields compared to bank deposits. As short-term interest rates peak, we expect market conditions for money market strategies will be favorable compared to both direct markets and bank deposit rates."
He continues, "Looking at flows in money funds in the second quarter, we saw good activity from products geared to the retail customers of financial intermediaries. Institutional product flows were challenged by the aforementioned debt crisis direct security yields and the regular June corporate tax period."
Donahue explains, "Now the SEC, as you know, recently adopted new rules for money market funds. We continue to study these rules to assess their impact. We were pleased to see that swing pricing was not included and that the ability to use a reverse distribution mechanism was included as an option [in the] remote possibility that negative yields were to occur. We were also pleased that the SEC agreed with our recommendation to remove temporary redemption gates and the link between weekly liquidity asset thresholds and liquidity fees, which we believe created an incentive for investors to redeem sooner in periods of market stress and prevented the manager from using as much liquidity as was available."
But he says, "The inclusion of mandatory redemption fees subject to certain conditions in institutional prime and muni funds presents a challenge for fund advisers and investors. We have approximately $11 billion in third-party institutional assets in institutional prime and muni funds that we believe could shift to alternative products that we offer, including our private prime fund and government money market funds. It's worth noting that institutional prime and muni funds already have fluctuating net asset values and that there is an exception or a carve-out for so-called de minimis impact based on the hypothetical selling of a strip of securities that may occur on the rare days when we have a 5% redemption trigger."
Donahue adds, "We will be talking with our institutional clients over the coming months on this topic. We believe that these investors will continue to use the institutional prime and muni funds, at least into late next year, when the new rules take effect. Our estimate of money market mutual fund market share, including sub-advised funds, was 7.2% at the end of the second quarter down from 7.4% at the end of the first quarter."
Asked about flows, Money market CIO Debbie Cunningham comments, "From the money market side of the equation, much of the growth that we have seen so far has come from the retail side of the market <b:>`_. And that's simply because, compared to bank deposit rates where they were for a lot of the zero rate environment, money market funds are now paying much more attractive market rate of return. For institutional buyers, however, they have the ability generally to be able to be in direct markets specifically, so buying direct commercial paper, buying direct CDs."
She tells us, "As the market [rates] have increased, they have been purchasing direct market securities such as those in order to pick up ... higher yield more quickly <b:>`_. Money market funds operate with a lag, maybe 25 to 30 days, depending upon what our weighted average maturities are. Once markets peak or plateau in this case, and ... even more so when they start to go down the other side, the opposite occurs for the institutional investor -- they come into those funds that actually lag the market and therefore, stay at that higher rate for a longer period of time."
Cunningham comments, "So it comes from two different sources. The retail side, as money is coming off of zero, and very attractive versus bank deposits. Then once rates plateau and start to go down even marginally, it comes from the institutional side ... these are generally cash managers' cash management flows. [This] doesn't include what Chris was talking about, those flows that ultimately may make their way back to the longer side of the fixed income markets or even the equity markets for that matter."
Asked about the new higher liquidity requirements, she answers, "So going from 10% in overnight and 30% in weekly liquid assets ... in the current rule, to 25% in daily and 50% [weekly] ... in the new rules, the only funds that will be impacted would be the Prime funds. [T]he municipal funds are exempt from any kind of daily liquid asset requirements, so it's only weekly liquid assets that would impact them. And from both a municipal and a government standpoint, they operate well in excess of those either 25% or 50% requirements for dailies and weekly.... It will have a basis point impact in ... prime retail and prime institutional, but they should still be able to maintain their competitive spread over the government sector."
Finally, when asked about consolidation, Donahue responds, "It depends on how the money got in there and who controls the money at the moment of redemption. So there are 50, maybe 60 listed money market fund players. The top 25 have all the assets, the top 20 are the only ones who really compete for the big assets. And it all depends on how that fits into your regular business. We have a sales force that goes around and calls on all the players in the money market fund business to ... be a warm and loving home should they decide to change their mind on doing this. And it's episodic. There was no avalanche after the last go-round of SEC regulation. I don't expect an avalanche out of this one. But periodically, CFOs, CEOs and managers decide that the time has come to what we've set to get out of it, and that's what we're looking for."
Cunningham adds, "I think what drives it [recent share gains] is that if you look at other money fund providers, that have a larger retail presence than we do that, and that retail sector being the largest growth sector, disadvantages us to some degree during an environment when retail is growing more than institutional. We do expect that to even itself out as rates increase only in a minor way going forward, plateau and then ultimately start going in slow fashion back down again. We do expect that to influence then the institutional side of flows in a much larger way where we play a larger role in that market."
