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

[Audio Gap] And we also have Ray Hanley here, who is the Head of Investor Relations and President of Federated Investors Management, which is the finance and administration arm of Federated. Ray has been with the company since 1985. So we're once again fortunate to have 2 multi-decade veterans with us today. So thanks to both of you for being with us today.

Thanks, Brian.

Thank you, Brian.

Great. So I'll start out with some questions of my own and leave time for questions for the participants as well. And we can even make it interactive as they come in. Just instructions on that, you can ask you questions right on that web portal, or you can feel free to e-mail me at brian.bedell@db.com, whichever is easier for you. So maybe if we can start out a bit high level. So the state of organic growth in the asset management industry has definitely been improving over the past few quarters. And there are several drivers of that, of course, one being strong demand for fixed income. And another being an improvement in active performance relative to passive substitutes, at least the way we're measuring it and since the downturn in the markets in the first quarter of 2020. So a question, I guess, for both of you, what are you seeing from the Federated Hermes side in terms of demand for your long-term products? Clearly, fixed income has been a major bright spot. But what are your sales force and distribution partners saying about the current environment? Which product of yours are you benefiting most from that new sales growth?

Okay, Brian. I'll go first on that. And as you know, we in Q1 was -- things did pick up, and we had exciting news over $200 billion in long-term assets. And by the end of the quarter, we were at $206 billion and it continues because last week, recently, we were at $210 billion in long-term assets. And we're seeing the convergence of strong products in a variety of strategies and strong distribution relationships that served us well and it served us well through the pandemic as well as our regional consultants had the cellphone numbers of their clients and utilized that successfully. And you also know in the first quarter, which you see in the industry, we had great -- we had record gross and net equity sales and total fund sales 15 -- over $15 billion and net of $3.5 billion here in the whole complex. Now looking at Q2 through the end of last week, we have net sales about $1.2 billion so far in our long-term funds and SMA strategies and net sales of about $1.3 billion in fixed income and about $470 million in alternatives, and these are partially offset by equity redemptions of about $600 million or so. Demand for fixed income strategies was very strong in Q1, and it continues to be solidly positive in Q2. And of course, the quarter is not over yet. Some of the things, Brian, that we're emphasizing on the international strategies to our clients, and we're seeing good demand, of course, in the sustainable strategies in the U.K. and some of the products, the Global Equity ESG, the SDG Engagement Equity, Global Equity Emerging Markets, Asia ex Japan and interesting SDG Engagement, high-yield credit and also the unconstrained credit run out of the U.K. We're also seeing some success in our trade finance strategy that we've been working for a long time to raise assets, and we have some nice wins there. So overall, it's still going pretty well.

Yes. No, that's great to hear, especially into the second quarter, which can be sometimes seasonally weaker than the first quarter, at least historically. So it sounds like the momentum is continuing. Maybe let's get into ESG and Hermes, and you talked about those products. I think you've definitely certainly been on the leading edge of this area with the acquisition of Hermes in 2018, literally right before flows into ESG products industry-wide began inflecting up strongly in 2019 in both the U.S. and Europe in terms of the way we were measuring it. In this past quarter, flows into your ESG products, I think were about $2 billion or near $2.5 billion. So that's about 3/4 of your overall flows almost, and I think, obviously, it looks to us like that was the best ESG results on a quarterly basis since the Hermes acquisition. But -- and correct me if I'm wrong on that. But obviously, Hermes has been benefiting from this for a long time. So what drove the sudden surge in inflows versus a more muted pace in prior quarters in those products? And do you think -- it's always hard to predict future flows, of course. But do you think that momentum on those Hermes U.K.-based ESG products are sustainable in the in the near and intermediate term?

Yes. Okay. Yes, we like to think we were smart, but we just got lucky with the Hermes acquisition. And the timing -- oh, yes, we're brilliant timers out there. No. We worked 5 years trying to get that transaction, getting to know them, and we're able to close it. And so it's really benefited. And as you know, we've taken what they do over there and integrated into our products here. But back to your question on -- yes, that was the best sales quarter that we've seen since we purchased them. So we're pretty excited about that. And we're seeing a broadening of clients' demand for sustainable strategies. And that's just beyond the historic -- just institutional strength. The wealth managers in the U.K. and EU are more and more seeking sustainable strategies for their customers. So the investors recognize that our international business over there has been offering successful active management and has a long history of the ESG integration across all their product lines. And the Hermes teams do that they really are leading this and invented it a long time ago. So it's pretty exciting. One other interesting thing, why the flows really picked up? So you know about fixed income picking up. And they have been working to build their fixed income team to build their presence, their reputation and their strong performance. And it just started to kind of kick in and is generating now much more meaningful positive flows. In terms of the second quarter, well, we're not predicting 1 more month in the quarter. But as we said before, they're solidly positive, and it continues, and we expect this to continue, and we also expect that the ESG demand for products is going to continue, and we are right in the sweet spot on there, especially the Hermes, the London team, with their background and track record. So we're pretty excited about our positioning.

Yes. No, it's good to see you participating in that growth. The way we're seeing it so far, and we're measuring the growth in ESG-dedicated products, at least on the mutual fund and ETF side, it is tracking -- for the industry is tracking 2021 much better than 2020, but both in passes -- anyway, so I think have to get some background here. So just talking about -- moving back on to ESG products in the U.S. So the Hermes style funds that were launched in the U.S. a couple of years ago. Are you seeing any sizable increases in demand for these U.S.-based products through your distribution channels? And if you can remind us of just how many sustainable funds were launched in the U.S.?

Sure, Brian. We've actually now launched 6 funds and 1 SMA product and these are all based off of, as you pointed out, successful Hermes strategies and actually managed by U.K. teams. And the assets collectively in these products, and many of these are -- really didn't come online until the end of '19. We're really just kind of launching effectively right in advance of the pandemic. So the assets across the suite of those products, about $140 million, and that includes about $38 million that we still have in or seed money. So they have steadily moved along, but in a typical pattern that we've observed for other fund launches, it takes some time to get critical mass to open up additional distribution opportunities. And so we continue to work through that, try to work on broadening the distribution. And certainly, the ESG macro as it takes hold in the U.S. should be helpful. And again, there's a great heritage behind these strategies. So we have high expectations for this group of products, but it will take some time to see them grow substantially.

Yes. And maybe just on that point on the financial adviser side, given that most of these products are sold through FAs. But I know you did a very good survey, I think, a little over a year ago now on ESG initiative -- or ESG opinions within the financial adviser community, and it was very pretty constructive on what FAs were saying about client -- both client desires to invest in ESG product and views on performance. Are you seeing that come to fruition yet? And are those conversations still quite fluid with the financial advisers in terms of at ESG demand? Or like you said, it's moving sort of gradually. And if it's the latter, what do you see as the major friction points?

We're certainly seeing heightened interest on the part of advisers. And one of the key findings in the survey that we published last September was that 90% essentially of the advisers that we surveyed reported being asked by their clients about ESG. And as the ESG is more in the beginning innings, so to speak, compared to the more developed view on ESG in the U.K., EU and in the channels that Hermes has built their distribution through. But nonetheless, we see tightened interest in the U.S. But commensurate with that, we're engaging with the advisers where they are in this process, which tends to be more in the beginning of it. So we recently -- and we just, in a press release on this not too long ago, announced the formation of a responsible investing institute, and that will offer training to the investment community about topics of responsible investing and how ESG factors work in investments. And so the first 3 courses that we're bringing out through this institute is an ESG 101 course to help identify what ESG is and what it's not. And then we'll offer an ESG data and investment implementation course and ESG business implementation course. And we're finding good receptivity. Advisers clearly need to know more about it to the extent that they're getting such a high pull-through from their client base for information on it. And we think we have a differentiated story to tell here. So we think it's a positive macro for us.

Yes. No, that sounds like it could definitely help stimulate more activity. Maybe just to stay with ESG, but switch gears to the investment side. So maybe just talking about ESG integration into the investment process on the Federated side of the business. The legacy Federated side of the business that is. I guess, what portion of long-term assets or number of funds do you -- would you say right now have ESG considerations fully integrated into the investment process? And then what does the investment process integration path look like from here?

Yes, Brian, I'll just give a comment. And then maybe Ray will follow up. This is the classic thing that my brother calls, our Hermes acquisition is a reverse transformational merger where we're going to learn from them. And that's what we've done.

And in doing so, we've made a commitment to being a global leader in active, responsible investing really across all the asset classes. And so commensurate with that, nearly all of our assets under management are have been fully ESG integrated. And we have the individual investment teams working with our responsible investing office. And they have a formal and customized, for each team, framework of -- to incorporate both proprietary ESG data, analytics and active engagement and the third-party data that we also utilize. And this is really just a natural extension of the primary research that they're doing. So we view this as improving investment performance and being additive to the investment process. We have an extensive in-house capability that differentiates our ESG approach. Our global team, we have 68 ESG subject matter experts spread out across our engagement, stewardship and responsible investing office and the background of these folks ranges from, we have climate change experts, we have ESG data scientists, we have former corporate sustainability officers, attorneys. There's a lot of talent being brought into the different sectors. And that's really been the EOS approach, EOS at Federated Hermes, which has kind of led on the stewardship front going back all the way to 2004. So there's a long history there. And we think it's unmatched in the industry. There's a 16-year database with detailed records on -- from the activity they've had with 20,000 issuers and being able to measure ESG progress and momentum over time to us is an important differentiator.

Yes. No. I mean, I think the -- as we talk to investment managers, and obviously, we had Michael Viehs from Hermes on our ESG panel back in March on this. And that integration process potentially should lead to alpha generation opportunities for active management. I guess, maybe just your thoughts on that for the -- I guess, really for the Federated funds overall because it's being integrated into the process, so that alone should be helpful for the active process. But then separating that from the actual ESG dedicated funds. So those are funds that we think of as other impact funds or funds in which the prospectus has actually changed to that ESG being a part of that investment process. So those funds are typically tagged as sustainable by Morningstar, for example, and we can measure the growth in those funds. We are seeing more demand for those funds even relative to other shops that have ESG integrated in non-ESG funds. So maybe just your thoughts on that. Do you -- the ESG integration is just helping the core legacy Federated funds? Or is there a view internally that you really want to launch more dedicated and branded U.S.-based ESG product?

So it's a bit of both. It clearly is a benefit, we think, to the active in-house investment management process. When you look at the ESG staff that I mentioned with a number of subject matter experts that we have. We -- our investment teams are able to benefit from interacting with the engagement team and what you get as a cross-pollination of fundamental and ESG intelligence, effectively, we get the best of both worlds. And so every PM and analyst now has the proprietary ESG tools on their workstation. And so again, it's additive to the high-quality work that they were already doing. Now to your question, yes, we will look at additional product launches that integrate ESG and including those that do so in a way that has the visibility that you outlined. We're looking at a couple of those now. I think it will be a measured approach, and we would like to get to the point over time that we observed that Hermes was able to get to, which is that ESG integration, responsible investing, is effectively integrated in everything we do. But that said, there -- the specific products that are more closely tied to it in a more thematic way, we have launched a handful of those, and we're looking at opportunities to launch a few more.

Okay. No, that's certainly very exciting, and I think that was a good comprehensive overview of ESG at Federated Hermes. Maybe let's move on to your money market business. We've seen somewhat of a stabilization within your money market flows in the first quarter after significant outflows in the back half of last year. But can you talk about the diversity of these flows and which channels they're coming from? If we talk -- if we think about retail brokerage cash vehicles versus institutional or corporate treasury? And then what portion of the assets do you view as sticky if we enter in more of a sustained equity bull market?

Well, we've observed, just to take the last part first, that historically, up equity markets have been very positive for the money market business, and it's a little counterintuitive. Yes, there is some money that will go to money market and to cash alternatives when markets get choppy, and it's logical to think that, that will return when the markets are doing better. However, for our client base, they tend to have a relatively constant, and I'm talking now about the institutional side, the trust departments, the other institutional investors. They will tend to have a consistent cash allocation to their portfolio. And so to the extent that they have gains in other parts of the portfolio, in this example, in up equity markets, they will tend to rebalance and reset and put additional money back into cash. In addition, in up equity cycles, there's simply more money moving around, money moving into the market, waiting to be invested, going to be invested over time. And so if you look at our charts and look at our history, we, in fact, show the pattern of movement in the S&P 500 and how that has generally correlated with growth in money market assets. Now more recently, it's been more institutional. We have a group that we call internally our capital markets function, which is effectively dealing with institutional brokerages. And that's been the source of the most recent -- a lot of the more recent asset growth. And as you point out, that's in a pretty limited window of time. And so we're hesitant to try to draw trends there. And it's always hard to assess the longevity of those positions. Money market, the money market business tends to have money flow in and flow out. And to the extent that there's more money in the system, higher liquidity levels, more stimulus money, those are all positive macros for the money market part of our business.

Yes. No, that's important. Background feedback again. Just quickly on the money fund flow. So thank you for giving us the long-term product flows. I don't know if you had the money fund flows also second quarter-to-date?

Yes. Well, let's say, quarter -- for the quarter, it's up about $12 billion.

$12 billion. Okay. Yes, very strong.

That would be a combination of funds and separate accounts. And I think you're familiar with the seasonality there. So the April tax payment they got shift into May. And so the funds are up about $3 billion and the separate accounts are up about $9 billion. The funds, of course, have -- tend to have money go out around tax time, people in entities making tax payments. Our separate account business is weighted toward paid cash pools. And so they're on the receiving end of tax payments at this time of year.