Federated Hermes, Inc. (FHI) Earnings Call Transcript & Summary

Good morning, everyone. Let's get started. This is Craig Siegenthaler from Credit Suisse, and it's my pleasure to introduce Chris Donahue from Federated Hermes. Chris is the firm's President, CEO and a Director. And he was initially named CEO back in 1998, which makes him one of the longest-tenured CEOs in the asset management industry. Chris' father, Jack Donahue, started Federated in Pittsburg in 1955. Chris, it's great to have you here with us.

Well, thank you, Craig. It's a pleasure to be here.

So Federal Hermes is a diversified asset manager with more than $600 billion of AUM and over $1.3 trillion in assets under advisory. The firm is best known for its money market franchise, which now manage more than $420 billion of AUM and for its acquisition of Hermes in 2018, which boosted its business in equities, fixed income and alternatives.

Okay, let's begin the fireside. In 2018, Federated made a transformational decision by agreeing to buy a majority stake in Hermes Investment Management, a U.K.-based asset manager, with a sizable alternatives business. Chris, how is the integration of this business fared? And can you talk about what trended better and also worse than you expected?

Well, thank you, Craig. Yes, the -- I like the use of that word, transformational. And I call it a reverse transformational merger where we wanted to bring many of the strong features of Hermes, its heritage in ESG, in particular, to marry up with our fiduciary heritage. And so this reverse transformational merger has worked really much better than some could have anticipated. Last year, just pre-COVID, we changed the name to Federated Hermes, Inc. and got a new sticker -- ticker symbol, and we have renamed all of our products all across the globe. In addition, we opened up our own responsible investing office for getting authentic ESG integration throughout the investment operations here in the U.S., and we have succeeded in that. And it is because of the driving philosophy that sustainable wealth is built through responsible investing. So that reverse transformational merger type stuff is what's worked really well. The people have worked well also. We had over 5 years of cultural due diligence to talk to the people and figure out if this could work, and it has. I'll just tell you one little feature of that is that both companies use the example of each individual has his or home dignity and gets to paying his or her own picture. And this helps analyze a lot of things inside the company. And that dignity also lends itself to the pledge, which Hermes had a pledge, we accepted a few of the English spellings of some of the words and then adopted the pledge here as well. On the product side, we've introduced 6 new products that now have 136 or so million in them. And it's still in the first inning. They're both funds, and we have some SMAs. So that's gone along pretty well. Last year, we completed the acquisition of control of the private markets businesses, the real estate and the private equity, infrastructure, et cetera. And we can talk about those later, but getting control of those is very important, and we were happy to do that. Another star in terms of things that have worked better than expected is the EOS at Federated Hermes, which, yes, as you mentioned, we ended the year at $1.3 trillion, but are now happily over $1.4 trillion, having added some more clients to that asset under advisement monitor. And this supplies us with great data, forward-looking ability to make judgments, a team of now 67 people. And it is a very, very much of a star in terms of engaging and setting things up for the future. Some areas where maybe some more things are needed. Well, in the fourth quarter after the acquisition, the emerging markets had its one of its cyclical dips. And that didn't help the AUM. That, of course, is bouncing back. So we're happy to see that. Another thing that needs more work is selling some of the stuff from the U.S. across the globe. And we combined our Asia Pac Group with Hermes International Asia Pac Group. And we're opening -- opened up an office in Sydney, Australia. On other parts of the globe, we've opened one in Madrid, hired an individual for our Latin America efforts. And we expect to see some more of the U.S. products sold in those jurisdictions. And we have good leads on some efforts in trade finance in short-term type mandates there. So that's pretty much a rundown of what I could think of right now for where we've done better than average and where we need to do some more work.

So Chris, instead of looking back now, let's look forward on M&A. As you and the Board evaluate your business today, what do you see as the biggest product holes? And do you think M&A could be used to fill these holes?

Well, the answer is, yes, M&A can be used, but it's usually on a smaller basis. The biggest product holes to get to that part of your question, are really ETFs. And as you know, we're working hard on those and hope by midyear to have some of those products up and running. Another hole would be a muni-SMA, and that could be handled through an acquisition and other things like that. We continue to look for bolt-ons and additions where relevant, and -- but we are really committed to being organic type growers. And so yes, M&A would be looked at by us as that type of operation, not so much get more size and do synergy. And to me, synergies is way of shooting people, and it's not as much fun as organic growth.

So Chris, if you look outside of Federated, we've seen a large increase in both asset manager transactions and also speculation around M&A. And so I wanted to know what is your thought on this trend and do you really expect it to continue over the next few years?

Craig, I do expect to continue. And the reason is that it has always been so. There's always new entrants. There's always things happening. And there are a couple of other features to it that are now new that we'll continue to prod these trends. One is regulation. One of the effects of regulation is oligopolization. Whether you like it or not, are you going to lament all the regulations, but that's one of the things they do is oligopolies because they make it harder for new people to get in or old people to hang in there. Another one that operates similarly is the pandemic. And just like you've seen the big boxes be able to survive better than the smaller companies, you're seeing that true here as well. And so these things still continue. What we believe is that an operation that is designed around a franchise for all seasons that has all sorts of opportunities to grow under any circumstances is where the strength lies. And that's the space that we occupy.

So Chris, let's move on to your alternatives business. It's roughly $20 billion of AUM, spans across real estate, infrastructure, private equity. Can you talk about your long-term growth prospects in this segment?

I'd be delighted to, Craig. The -- basically, this whole operation could be as big as the current operation that we have right now. I notice, I don't put a time line on that or divide the money up among all the various segments. But if you think about the real estate, okay, it's U.K.-centric. MEPC is the name of the entity that we bought control of, and they did this operation called King's Cross in Northern London that's just incredible. 67 acres, they get 50 buildings that have either been rehabbed or built new, 8 million square feet, 26 acres devoted to public space. All of this is done with a sustainable overlay and strong value creation. So I don't just tell you about King's Cross because we're proud of it, which we are, but because of what this organization does, and they're involved in other things in the U.K. as well. And we're figuring -- trying to figure out how to bring that over to the U.S. On HGPE, which includes the private equity and the infrastructure, they have about 8 billion in that -- by the way, it was 8 billion in real estate. So another 8 billion is in this area. And we have New York office. We're starting to make the calls on the dealers who deal in private equity. We're looking to get the existing clients to add into their existing positions on our PE offerings. We have had a great record, a thematic approach, and we are optimistic about being able to bring this stateside as well. One of the ones that you might see some numbers on faster than the others you're not expecting would be on direct lending. And this is something that we find quite interesting, and we're working on it. So that's a capsulized version, but it has enormous potential.

So Chris, low interest rates are probably benefiting a lot of those businesses, but low interest rates may also -- not may -- they're hurting you right now via the fee waivers, but there are some offsets, distribution, expense offsets. Can you talk about the impact from the fee waivers and low rates today? And then also, how should we think about the benefits alternatively when the Fed starts hiking at?

Right. Well, you get right into the beauty of a franchise for all seasons because we try to structure this whole enterprise so that what happens with rates, what happens with pandemics, what happens in the world, we can still do a great job for our clients. So now specifically on the low rates. Yes -- and we told the Street at the call that we had gone from an announcement of $9 million a quarter for the fourth quarter of waivers to $14 million for Q1 of '21. And we're not changing that. In terms of the rates and having recently spoken with our people about this post-Powell testimony, our belief is that this stimulus is going to roll out by mid-March or so, and that'll lead to more T-bill issuance and supply. And so we'd expect 1 or 2 basis points of increase in rates to come from that. Moreover, we also believe that they're going to start moving the repo rates and the interest on excess reserve rates and move them by 5 basis points each, the repo from -- the reverse repo from 0 to 5 and the IOER from 10 to 15. And the reason is that they like to have a base of about 5 in the short-term money. It adds proper oil and grease to the mechanics. And so the low rates are here, and we don't think that they're going to change that or blink this year. We're well aware of all of the discussions of inflationary pressures and all of that. But now the second part of your question was, well, what happens when they start to raise rates again? Well, our experience is that the AUM goes up because you get more return on your cash. Obviously, the rates go up, the waivers go down, but don't forget, the cash is always looking for a warm and loving home. And we always have a warm and loving home for all the cash. So to us, you look at things like the increases in M2, money supply, stimulus, all of this is more money flopping around in the system that will want to find at least a temporary home with money funds.

So if we think about the positive interest rate sensitivity in the money market franchise with the fee waivers and then you also have a value tilt in your equities business, do you just Federated is better positioned than most asset managers for a stronger economy and a higher rate backdrop?

Well, the -- let me just quibble with the value tilt. In our equity strategies, we have about $23 billion in the strategic value dividend mandate area, and we've got $23 billion in the growth area as well. Now MDT is kind of on both sides of that. So with that quibble, I would say that the strategic value dividend fund is peculiarly well situated for a rebound in value type stocks. It was up 4%, while the market was up 4%, and also pays a 4% dividend here in 2021. So we're looking for good things here, and we think that does position us. But the real positioning has to do with the fact that we have 40 funds of all varieties that have positive flows here in -- at the end of last year and still in the first quarter. They have excellent performance. And so you say, how are we set up? Well, it's this franchise for all seasons. If you look at our equity assets, they were just under $92 billion at year-end, and now they're just a hair under $98 billion. And if you look at the fixed income, we were $84 billion, now we're almost $88 billion. And yes, the -- on the liquidity side, in money markets overall, we've gone from 420 to 408. So that's down. But when you look at the flows, the equity flows so far this year remain positive with the funds being up more than the SMAs are slightly down. The fixed-income funds and SMAs are up well over $2 billion so that our net flows to date are about $2.25 billion. Now you're not allowed to multiply it by 6 and do all that kind of jazz. I don't know what's going to happen into the future, because if you do have uprates, fixed-income products sometimes don't do as well. Although on the high-yield side, we offer opportunistic high yield, which has equity in it, tips and then have the yield curve. So on the money funds, everybody knows that we've been committed to this business since the MI demand run if not to the contrary, and that we will fight them on the beaches to keep it going. And we're also bringing out micro-short funds. And I'm allowed to talk about these now because they're actually effective, so there's no gun-jumping, but these are between ultra-shorts and money markets. And the yields so far are right in between them and we have very strong interest from clients in these products. And I think they're going to do quite well. So that when you look at our positioning growth, value across the spectrum on fixed income and across the spectrum on money markets, I think we are extraordinarily well positioned as an asset manager.

So I'm just going to remind the audience, we have about 20 minutes left, but if you have any questions, you can see Carin's e-mail. Please shoot an e-mail. We can get your question too. But Chris, let me continue here. So Federated has been one of the leaders in the money market business. They helped to innovate the product. It's more than half your AUM, but a smaller profit contributor. How has this business changed over the last 10 years? There's been some M&A by yourself and some of the other leaders. And what does the competitive landscape look like today?

Well, the way this business has changed over the last 10 years is that they're used to be well over 200 competitors in this business. Now if you look at the list, there's about 50, and only 10 of them compete for money. And so it has, in fact, oligopolized. Another big change that occurred with those amendments that were adopted in '14 and then implemented in '16, which basically eliminated the dollar in dollar out net at $1 net asset value in prime funds for institutions, and so you had $1.5 billion -- I mean, $1.5 trillion move out of prime and basically move into govies, a giant crowding out. And the muni funds weren't able to get to their previous peaks of about $500 billion. So that changed a lot. And I think what really happens there is that both clients and issuers are hurt. And it's not like they can't fund. The people always point out, well, municipal issuers can still issue. Yes, but they have to issue longer at higher rates. And you eliminate or diminish the ability of the marketplace at the spear point of the short-term market to price things properly, meaning when back in the day, there was a more robust short-term muni money market operation, we would compete against Fidelity and JPMorgan and Goldman for a $10 million piece of paper coming out of some municipality. And that just doesn't happen anymore. And so competitively, the situation is there are less of them, but they are very, very difficult competitors, very challenging, but it remains a very strong, resilient business.

Got it. Chris, we actually have a question from the audience on flows. I know we're a little more than halfway through the first quarter, but are you able to provide us any update on fixed income flows and equity outflows?