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

Greetings. Welcome to the Federated Hermes Q2 Analyst Call and Webcast. [Operator Instructions] Please note, this conference is being recorded. I would now like to turn the conference over to your host, Ray Hanley, President of Federated Investors Management Company. You may begin.

Hello, and welcome. Thank you for joining us today. Leading our call today will be Chris Donahue, CEO and President of Federated Hermes; and Tom Donahue, Chief Financial Officer. Joining us for the Q&A are Saker Nasevi, the CEO of Federated Hermes Limited; and Debbie Cunningham, our Chief Investment Officer for Money Markets. . During today's call, we will make forward-looking statements and want to note that our actual results may be materially different than the results implied by such statements. Please review the risk disclosures in our SEC filings. No assurance can be given as to future results, and Federated Hermes assumes no duty to update any of these forward-looking statements. Chris?

Thank you, Ray. Good morning all. I will review Federated Hermes business performance, Tom will comment on our financial results. We ended the second quarter with record assets under management of $912 billion, led by growth in equity and private market assets. Equity assets closed the second quarter at a record high of $110 billion. During the second quarter, equity assets increased by $8.8 billion or 9% from the first quarter reflecting solid market value gains. Gross equity sales were $9.1 billion in the second quarter, just about even with the first quarter's record level. Equity net redemptions in the second quarter were $1.1 billion, which included the expected global equity sub-advisory redemption of $3 billion that we discussed last quarter. Equity sales results were again led by our MDT fundamental quant strategies. MDT equity and market-neutral strategies had a record $6 billion of gross sales and over $3.5 billion in net sales in the second quarter. Looking at Fund performance rankings at the end of the second quarter, 6 of 9 MDT fund strategies were in the top performance quartile of their Morningstar categories for the trailing 3 years. We had net sales in 35 equity fund and SMA strategies during the second quarter, including a variety of MDT offerings, which contributed $2.7 billion not including market neutral, which we'll discuss later; and strategic value, which had $470 million. Looking at our equity fund performance at the end of the second quarter and using Morningstar data for trailing 3 years, 54% of our equity funds were beating peers and 30% were in the top quartile of their category. For Q3, through July 24, combined equity funds and SMAs had net sales of $61 million. Now turning to fixed income. Assets ended Q2 at just over $100 billion, up $689 million. Market appreciation added $1 billion and was partially offset by net redemptions and exchanges. We had 26 fixed income funds and SMAs with net sales in Q2, led by Core Plus and Core Ag SMA, which combined for $190 million. with 3 Ultrashort funds that were up a combined $134 million, and the conservative muni micro short fund was up almost $100 million. Regarding performance at the end of Q2 and using Morningstar data for the trailing 3 years, 39% of our fixed income funds were beating peers and 19% were in the top quartile of their category. Now for Q3 through July 24, combined fixed income and SMAs had net sales of $362 million. In the alternative private markets category, assets increased $2.6 billion in Q2 to reach $21.6 billion. The completion of the acquisition of an 80% interest in FCP Fund Manager LP in early April, added $3.2 billion of U.S. multifamily real estate managed assets. The MB2 Market Neutral Fund and its ETF combined for $150 million in net sales. Now we're in the market with our global private equity co-invest fund, which is, of course, the sixth vintage of the PEC, the PEC series. To date, we've closed on $300 million, PEC 1 to 4 raised $400 million to $600 million in each fund and PEC 5 raised $500 million. We're also in the market with the European real estate debt fund, which is a new pooled European debt offering. Across our long-term investment platform, we began Q3 with about $3.4 billion in net institutional wins yet to fund into both funds and separate accounts. Equity strategies are expected to have net sales of about $1.7 billion with MDT additions of $1.6 billion and a global equity additions of about $150 million. Approximately $1.3 billion on a net basis is expected to come into private market strategies, including direct lending of about $700 million, private equity of $538 million and trade finance of $100 million. Fixed income is expected to have net sales of about $300 million, including total return bond, low duration and high yield. Now moving on to money markets. Total money market assets decreased by $7.9 billion or about 1%. Money market funds decreased by $2.9 billion or 1% and from Q1, yet we're up almost $32 billion or 7% year-over-year. After ending 2025 at a record high of $508 billion, money market fund assets have decreased slightly over the first half of the year to $500 billion at the end of Q2. Money market separate accounts decreased by about $5 billion or 3%, similar to last year's Q2 decrease of $5.8 billion. Still, these assets were up about $10 billion or 6.4% year-over-year at the end of Q2. Money market separate account assets are impacted by the liquidity levels of the large state pools that we manage and typically peak with tax collections at year-end through mid-April before decreasing in Q2 and Q3. Our estimate of money market mutual fund market share, including sub-advised funds was about 6.7% at the end of Q2. down from 6.9% at the end of Q1. Now looking back to the last 7.5 years or so, of quarterly money market fund market share changes, we gained share in 14 quarters. We lost share in 14 quarters with 2 quarters of no change. The average share gain was $0.20. The average share loss was about $0.23. Our money market fund managed assets more than doubled from $208 billion to $500 billion over that period. This is certainly entrepreneurial delight from an owner operator. And of course, it's important to note that we remain in the top 10 in every category of money market fund managed asset levels in the top 5 in prime and tax-free. Now let's talk about digital. Our digital initiatives include the recent launch of money market management digital treasury fund which is expected to support both traditional and on chain distribution. The initial reserve shares class provides a nontokenized genius compliance structure geared to institutional investors and stable coin issuers seeking investments aligned with stable coin reserve requirements. We are also developing an on chain share class intended to place official books and records of that share class on blockchain infrastructure as we implement a digital transfer agency model. This dual-track approach offers flexibility between traditional and on chain record-keeping models. We have selectively engaged with regulated digital asset intermediaries focusing on tokenized funds as regulated financial instruments. We've previously discussed our participation in the BNY and Goldman domestic initiative involving mirrored tokenization. -- and the RX initiative to offer tokenized assets to a UCITS money market fund in the U.K. We are engaged in the digital asset development discussion with several other intermediaries. These are early-stage efforts. Our clients are currently looking more for digital asset information than transaction ability. We expect our engagements with intermediaries to grow as regulations clarify and as our digital assets platform and product development progress. Now let's look at the recent asset totals as of a few days ago. Managed assets were approximately $899 billion. We should have picked the day before, including $665 billion in money markets, $109 billion in equities, $100 billion in fixed income, $23 billion in alternative private markets and $3 billion in multi-asset. Money market mutual fund assets were $490 billion, Money market fund assets have ranged from $490 billion to $501 billion during July with average asset levels of $496 billion. Tom?

Thanks, Chris. For Q2 compared to the prior quarter, total revenues increased $23.8 million or 5%. The FCP acquisition added about $14 million, $9 million of it in the IAF category and $5 million in the other service fees. Equity asset growth added $7.6 million an additional day added $5.1 million. In private markets, Rivington had a $2.9 million gain on sale of a renewable energy property recorded in other service fees. And the U.K. real estate business had a $2 million real estate development fee for a project that did not advance into construction also recorded in other service fees. These increases were partially offset by lower Q2 money market average assets, resulting in $8.4 million in lower revenues. Total carried interest and performance fees were $1.4 million compared to $388,000 in the prior quarter. Approximately $682,000 of the Q2 fees were offset by compensation expense. Q2 operating expenses increased by $17.3 million or 5% from the prior quarter due mainly to an increase of approximately $9.7 million in transaction costs from the FCP acquisition, including $6.5 million of nonrecurring acquisition-related compensation and $3.2 million of higher professional service fees, including FCP, lender consent fees and other professional service fees. Compensation and related expense in addition, increased $6.9 million due to FCP's quarterly compensation expense [indiscernible] normal merit increases and other factors. This was offset by seasonally lower stock-based compensation expense of $6 million. Higher advertising and promotional activities added $3.2 million as we had our spring advertising campaign. Intangible asset amortization increased $3 million, primarily from the FCP acquisition. These expense increases were partially offset by lower distribution expense, which decreased $4 million due mainly to lower money market fund average assets. In the other expense line item, the Q2 increase was due mainly to FCP property management expense of $2.8 million. The combined Q2 impact of the revenue from the Rivington gain on property sale, the U.K. real estate development revenue fee -- the CP acquisition-related comp expense and professional service fees was about $4.7 million of lower net income or about $0.06 per share. The Q2 effective tax rate was 25.8%. We estimate the tax rate to be in the 25% to 28% range for 2026. At the end of Q2, cash and investments were $481 million. Cash and investments, excluding the portion attributable to noncontrolling interest were $416 million. Holly, we would like to open the call up for questions now.

[Operator Instructions] Your first question for today is from Bill Katz with TD Cowen.

This is Robin Holby on for Bill Katz. We wanted to ask on fixed income. Gross sales were up nicely quarter-over-quarter and year-over-year, while net flows seem to have somewhat stabilized. Has investor interest changed at all with the prospects of higher rates? And do you think the strategy can get back to positive net flows in the foreseeable future?

Well, the reason we mentioned about the flows right now is that they have gotten exactly there. If you talk about the attitude of our intermediary client base, 1 of the things I'd mention is that the end clients have become kind of numb to all the negative geopolitical news and issues. But with interest rates under the worst regime staying the same, what we're seeing is a little more interest in things like, as I mentioned, the conservative micro short and, of course, the ultrashort funds. And that bumps a little bit into the money market fund thing as well. So there are no definitive answers. There is no macro answer to that is going to take us through the next quarter. We think our products, including our payer ETF, which gives a little higher yield and the FAs and the clients like that. has had good response as well. And so we think the variety of products out the yield curve. The strength of the team and the investment management will entitle us to positive flows here in the foreseeable future in fixed income.

That's helpful. And then I wanted to follow up on strategic value. You mentioned it in the prepared remarks, the fund has solid year-to-date performance. Just maybe how are your conversations with investors tracking there?

The investors like the performance, but we don't like being in the category because we're either on the top of it or the bottom of it. And this always attracts the attention of the portfolio manager who just likes doing what he's doing, which is increasing the dividend growth of dividend and the dividend. On the other hand, when you look at the ETF also doing well, these are people who come in who haven't had the experience of the fund who understand exactly what the fund is doing. And so -- this is a very, very positive thing on both sides. And I would say that the biggest challenge we have is that when those prices of those securities go up, the portfolio managers have to make some maneuvers, change them in order to keep the dividends going. That is a good problem.

Your next question is from Kenneth Lee with RBC Capital Markets.

Just one on the money market fund assets there. just given the rate outlook and the employment there, any updated outlook in terms of potential asset growth for this year?

Well, let me comment first, and then I know Debbie is jumping it a bit to get at this one. But in terms of the money market fund overall, we've been at this for 50 years. And there's all sorts of things that come together like our rivers and a big confluence month-to-month. That's why I went through all those percentages of changes in market share. But because of the seasonality I think that says for itself that we do expect that seasonality to come back just like it has. All these years, we've had these pools. Some other interesting things have happened in the marketplace. One of the big firms offered sort of a bonus yield program that moved some assets. We had some big clients move that always happens. . As I mentioned in the previous question, we had some ultrashort and people moving out the curve a little bit. But with the Fed situation, if it is really higher for longer, i.e., they don't do anything, that's fine with us. Remember, 3.5-or-so percent yield on a money fund is a great thing. Debbie?

Thanks, Chris. Yes, I agree. A lot of volatility in the first half of the year, there were some very large market deals that occurred from an IPO standpoint and a long-term debt standpoint, Amazon and Alphabet and tropic base they issued large amounts in the marketplace, which then subsequently for a period of time came into the money market universe and has subsequently gone out some of it left in there. So a lot of volatility and noise around the first half of the year. But ultimately, what Chris mentioned with regard to a worse led Fed that at this point is showing no suns of being in the mode of lowering rates keeping rates higher for longer, where they are now. I mean the market is actually predicting that the rate environment is increased at the September meeting, which I don't particularly think will be the likely scenario. But nonetheless, if you're -- with rates on the short end, somewhere between 3.5% and 4.5% on a yield curve basis over the first half of the year. money market funds look very attractive. Most of the industry, including ourselves, has lowered their weighted average maturities to have some fuel available to light the fire even further as rates and the yield curve steepen to some degree. Floaters are really good use of investments in these funds during a rising rate environment, and those have been plenty full in the marketplace. Sometimes we like the spread in the floater sometimes we don't. But all of this really leads us to a conclusion that with rates where they are marginally higher from a steeper yield curve standpoint, the attractiveness of cash and the attractiveness of money market funds as well as the separate accounts and the pools that we manage will continue to gather assets as on the industry.