Federated Hermes, the 7th largest manager of money funds, reported Q3'23 earnings and hosted its Q3'23 earnings call late last week. The release quotes President & CEO J. Christopher Donahue, "Record assets under management at the end of the third quarter were again driven by money market asset increases, particularly investor demand for our prime money market offerings in the current interest rate environment, where general market volatility made the improved yields of our cash offerings an appealing haven for investors. Net sales of fixed-income products were led by multi-sector fixed-income separate accounts and net sales of our flagship core-plus offering, Federated Hermes Total Return Bond Fund." (See the Seeking Alpha earnings call transcription here.)
On the earnings call, Donahue explains, "We had solid asset growth in Q3, ending with record assets under management of $715 billion, driven by record money market assets of $525 billion. Fixed income produced solid growth as well.... We reached record highs for the money market assets of $385 billion, and total money market assets of $525 billion. 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, of course, favorable yields compared to bank deposits. A short-term interest rates peak, we expect market conditions for money market strategies will be favorable compared to both direct market rates and bank deposit rates."
He continues, "Looking at flows in money market funds in the third quarter, we saw good activity from products geared towards the retail customers of financial intermediaries. Institutional product flows continue to be challenged by direct security yields. Our estimate of money market mutual fund market share including sub-advised funds was about 7.3% at the end of the third quarter, up from about 7.2% at the end of the second quarter. Looking at recent asset totals as of a few days ago, managed assets were approximately $716 billion, including $527 billion in money markets.... Money market mutual fund assets were at $385 billion."
CFO Tom Donahue comments, "Revenue from money market assets decreased by $9 million, offset by an $8.2 million decrease in related distribution expense. Changes in certain product structures drove these decreases, while higher average money market assets added to revenue. Q3 operating expenses decreased $33.6 million from the prior quarter due mainly to compensation related to carried interest and performance fees in Q2 and to lower money market fund distribution fees as discussed."
When asked about MMF flows when rates peak during the Q&A session, Chris Donahue responds, "Once those rates begin to peak, you begin to attract the institutional money, which is ... more attracted to direct securities at this point in time. So we would expect to see institutional flows increase. But right now, on the retail side, ... we're in a very good position with the rates, and when you combine that with the reticence of financial advisers to take positions ... they're waiting on the Fed and getting paid 5%-plus. It's hard to say exactly when they will decide to go longer. But that would be the basic outlook."
He also says, "Don't forget that, as we've mentioned before, when we look at the last cycles from '16 to '18 ... after the initial decline, the money market fund assets increased by 15% and then the industry did about the same about 11%. And we continue to grow with higher rates, of course. Then the other thing we like to mention is that, basically, our assets grew about over 20% through Q3 of '19 when they began to ease....[I]ndustry assets also grew at a smart clip then. So that's the basis on which we come to those kinds of observations."
Money Market CIO Debbie Cunningham tells us, "You mentioned ... the extension trade, and we do that even within money markets. So we started out this cycle with weighted average maturities/durations down in the single-digits to teens.... We're now out much longer, 30, 40, 45-type days [and] have done the extension trade in order to keep the yields higher within the product itself. I think another thing that's helpful is that during the zero-rate environment, so many cash managers got used to bucketing cash. So a certain amount, that's kind of operating [or] day-to-day, stays in the government sector."
She continues, "Next, kind of more strategic, goes out into prime and then ultimately, microshort or ultrashort, in the longest bucket. But when you're looking at a higher-for-longer scenario with a yield curve that from overnight, say 5.25% to 5.30%, out to 10-year bonds at just under 5%, you're looking at something that is a market that's finally reconciling with that Fed statement 'higher for longer.' So I think the flows, as Chris mentioned, will continue in retail, and we'll do nothing but grow in institutional."
Federate Hermes President Ray Hanley states, "I would just add, we're well positioned for people deciding to extend out on the curve with our fixed income product array. And in particular, people are interested, as evidenced by the flows in our Total Return Bond, Core Plus strategy with a six-year weighted average effective duration. It's really well positioned. We've been talking to clients all year. The cash yields are very attractive, so ... there is a certain amount of waiting for the right time. But when that trade happens, we have a lot of good strategies that can catch the money going out further."
Chris Donahue adds, "One more comment [to add] is that the Ultrashort funds are starting to turn. They haven't gotten positive yet right here in this first couple of days of this month or quarter, but it's getting a lot closer. And the Government Ultrashort Fund has just done a pretty good job on flow. So you're seeing people go out there. And remember, that's currently a $5 billion franchise that we have here [with] Ultrashort funds on all three streets."
Asked about mergers and acquisitions, Tom Donohue says, "On the money fund side, and on the -- what we call 'roll-up' -- side, where people decide it's time for them to turn it over to us, we are active in talking to people. On bigger deals, those things take time to do. And I don't have a list of things to announce."
When asked whether investors are "over-indexed" to cash, Chris Donahue answers, "I don't have statistics good enough to make a judgment as to whether the retail clients are over-indexed to cash or not. The incidental information we get based on our salesforce, which is robust, is that they are just very, very, very, very unsure about what to do. So that would mean they would have more money than the average bear would think in the money funds.... We don't participate as vigorously as others do in this so-called 'cash sorting' because the products we offer are the ones that give the marketplace yield across the board."
Cunningham responds, "The only thing I'd add is that if you look at our money market fund assets as a percent of our total liquidity assets, they are basically growing equally. It's about three-quarters money funds, one-quarter other types, whether it's in local government investment pools, separate accounts, collectives, privates, offshore. The rate of growth seems to be commensurate for both types of liquidity products. It doesn't seem like people are overweighting the money fund side of it."
Asked about the sensitivity to "platforms" and money market allocations, Donahue replies, "We look at the charts we keep on the terms of the assets that are in that field, but that isn't going to answer your question. If I take you to the chart that shows you how much is in broker-dealer and retail, that's not going to answer your question." Cunningham adds, "`I can say that for our largest distributors of ... retail money market funds, they're, number one, very diverse; and number two, all experiencing large amounts of growth in the 2022-2023 timeframe. So it's not heavily weighted to one institutions' preference or sales or allocation tactic. It's across distributions."
