Federated Hermes, the 5th largest manager of money market funds, reported earnings Thursday and discussed a number of topics involving money funds during its conference call Friday morning. (See Seeking Alpha's Earnings Call Transcript here.) President and CEO Chris Donahue comments, "Moving to money markets, the Q3 asset decrease of $25 billion was mostly from money market funds, which decreased from Q2's record high, and to a lesser extent seasonal declines in separate account assets. Money market fund asset decreases were attributed to corporate clients using cash to pay down debt or spend on their businesses and ... the use of cash by government entities among other factors. Our money market mutual fund market share including sub advised funds at quarter end was nearly unchanged from the prior quarter at 8.1%."
He explains, "Taking a look now at recent asset totals, managed assets were approximately $614 billion, including $430 billion in money markets, $81 billion in equities, $81 billion in fixed income, $18 billion in alternative and $4 billion in multi asset. Money market mutual fund assets were $322 billion."
CFO Tom Donahue tells us, "Total revenue for the quarter was up about $4 million from the prior quarter due mainly to higher equity and fixed income assets, which combined to add about $20 million of revenue. This was partially offset by net money market minimum yield and other waivers and lower money market assets, which combined to reduce revenue by about $18 million."
He continues, "Recall that in Q2, we saw revenue growth from higher money market assets partially offset by lower revenue from equity assets. Our diversified business mix positioned us to grow revenues in varying market conditions against the backdrop of challenging times. Other factors impacting Q3 revenues, compared to the prior quarter included an additional day, which added $4.4 million and a decrease of $2.9 million in performance fees and carried interest.... The decrease in distribution expense compared to the prior quarter was due to the impact of minimum yield waivers and lower money market assets, which reduced distribution expense by about $18 million."
During the Q&A session, J.P. Morgan Analyst Ken Worthington asked, "Regulators and regulatory panels continue to kick around the idea of altering money market fund regulations again in response to the need for Fed programs to support funds post COVID. What are the fixes that are being most talked about? And could this round of rules either damage the outlook for prime money market funds? Or is it more likely that it actually helps the outlook for prime money market funds?"
Chris Donahue answers, "I believe that the thing that's being talked about the most is the restriction on that 30% trigger. The comments that were made to the SEC of not only requiring the 30% weekly liquidity level, but then requiring the public notice thereof, and then the consideration by the board of fees and gates acted exactly the way that was predicted. Namely, it caused more problems than it solved. And there are a lot of ways around that. If the SEC wants to keep the trigger, fine. You just don't have to do the things that wave a red flag in front of the marketplace."
He continues, "Ameliorating the impact of that 30% is the number one thing that's being discussed. At this point, in our view, the money market funds came through this situation much like they did before, with a lot of resilience. Therefore there is no need to further diminish prime funds, even though there are some who use them as trading mechanisms in order to preserve their non-SIFI status."
Donahue adds, "The reason for this is, if you take an honest look at stakeholders, including the issuers [like] colleges and municipalities, all of whom need great help, during COVID, and post COVID times, restricting their ability to get financing on the short end doesn't make a lot of sense. And you have the users, ... and then you have the other shareholders. We just don't think that it makes a lot of sense to eliminate the spear point of the short term markets at this time. So what will happen with regulation? I cannot predict, but I can assure you that we will be in there defending the beauty and efficacy of prime money market funds."
Worthington also comments, "You had pretty substantial outflows in money market funds this quarter, and pretty strong net sales into fixed income funds this quarter. To what extent is the money that's coming out of cash going into fixed income? And really the heart of the question is, 'To what extent can you cross-sell or cross-market cash management clients and really the intermediaries to kind of retain those dollars coming out of money market funds?'"
Donahue responds, "A truly lovely concept that doesn't work and I can't defend. If I could, I would. We have discovered over the many, many decades of being in the money fund business, that the money fund and cash determinations by clients are made on the basis of cash. But what happens is because you're there with the cash account, you can talk to them about the other beautiful options that you have. But to be able to exactly calculate and follow money moving from cash into fixed income we just have never been able to do. We have separate sales organizations who coordinate very closely. And I think a large part of the sales that we had in this quarter were related to the breadth and quality of the fixed income offerings that our clients were able to see. And so you can be sure that the salespeople on the fixed income and equity side use the money market fund as a door opener. It's just very difficult to trace the money."
In response to another question on fee waivers, Tom Donahue replies, "There's a whole lot of assumptions ... asset mix, client actions, and then you just mentioned the stimulus.... If you track our forecasts, surprisingly because of so many factors we've been pretty accurate. Basically, our team thinks that there's going to be a stimulus package, and the size and the timing matter. And as we run through so many factors, we came up with an estimate that was $9 million. I guess if the stimulus package doesn't happen we would run the numbers and get a couple million more in wavers."
Money Market CIO Debbie Cunningham comments on ESG integration, "I think probably the reason that we are the most fully integrated group within the three different sectors at Federated Hermes has to do with the fact that we abide by Rule 2a-7. Our money market funds ... are required to only deal with issuers that represent minimal credit risk [and are] high quality. So for the most part, we're dealing with the largest companies, the largest financial entities in the world, on a global basis. As such, even though there may be issues from a governance perspective, ... there may be environmental issues for the BPs and the Exxon's in the world, there may be social issues from some of the pharmaceutical companies that we're using, etc."
She continues, "But the fact of the matter is, they're the leaders in the industry, and we are engaging with them to move forward so that they can move those issues from an industry basis, in a positive direction. So that's kind of our modus operandi, if you will, within the sector, some of the incidental observations that we've noted from the COVID perspective have a lot to do with firm's adaptability. One of the issues that we have engaged with a very large, soft drink manufacturer has been their use of plastic, yet during COVID times back in March and April, they actually took several of their plastic manufacturing lines, their bottling lines, and turn them into PPE manufacturer. [There are] similar stories from say Walmart and some other retailers who repurpose their individuals and on a social basis did not necessarily lay those individuals off. So incidental observations have been good."
When asked if Q4 would see inflows into MMFs, Cunningham answers, "Sure, generally speaking, our liquidity products do see inflows at the end of the year. That may be mitigated to some degree by lower interest rates and by what was already a huge inflow in the second ... quarter. So already, a lot of that cash was in our products, and maybe different types of cash was included -- stimulus cash that's now being utilized for its original purpose, sort of flight to quality cash, etc."
Finally, she adds, "You'll see flight to quality if there's any kind of contested or questionable issues associated with the election. You'll probably see Treasuries go a little bit lower in that interim time period, repo go a little bit lower on a rate basis because of flows coming in. So demand exceeding supply at that point until we do get some stimulus in the marketplace. On the other side of the market, with the credit markets from a prime and muni standpoint, it's more than likely that you'll see a little bit of spread widening and some outflows if that would in fact be the case. But generally speaking, the fourth quarter is usually a strong one for positive flows."
