Federated Hermes hosted its Q1'22 quarterly earnings call on Friday, which contained comments on money fund fee waivers, swing pricing, rising rates and more. CEO Chris Donahue comments, "Moving to money markets, assets declined about $27 billion in Q1 compared to Q4 totals, as money market fund assets decreased by $33 billion, and our separate account money market assets increased by about $6 billion. Our total money market assets at the end of Q1 were just above the total that we had at the end of the first quarter of '21. Seasonal trends impacted both money market funds and separate accounts. Rising interest rates and competitive pressure also impacted money market fund asset levels. Our money market fund market share, including sub-advised funds, was about 6.9% at the end of Q1, down from about 7.4% at the end of 2021." (Note: See also The Wall Street Journal's "Making Your Cash Work Harder as Interest Rates Rise.")
He explains, "Now, with the first Fed hike last month, and a series of additional increases expected, money market fund minimum yield related fee waivers decreased in Q1. Tom will update us on our yield waiver outlook. Market expectations are that the Fed will increase the pace of interest rate hikes. While we welcome higher money market yields, we believe that measured increases would be better for money market funds compared to direct investments. However, though more rapid rate increases may initially favor direct investments, we believe that higher short-term rates will benefit money market funds over time, particularly compared to deposit rates, and we've noted."
Donahue continues, "We said during the last quarter, that during the last Fed increase cycle that began in Q4 of '16, through the last rate hike in Q4 of '18, after an initial decline, our money market fund managed assets increased by 15%. The industry followed a similar pattern, with an initial decline, followed by a growth of 11% over that same timeframe. The higher rates helped us continue to grow these assets by an additional 22% through the third quarter of '19 when the Fed began to ease. Industry money market fund assets also grew in this period, showing a 14% increase."
He tells the call, "Now, on the regulatory front, we recently filed two comment letters with the SEC on their proposed money market fund rule changes, including a primary comment letter of 115 pages, and a separate 45-page letter on the deviance of swing pricing. Our comments and those from others note that swing pricing is not a workable alternative for institutional prime and muni money market funds. We believe that most institutions would not use these products if swing pricing were to be imposed. In addition to uncertainty around redemption proceeds, from a client's point of view, large-scale systems changes would be required by money fund managers, intermediaries, and investors, to even enable swing pricing to function. In our view, few, if any, will undertake these efforts. As a result, we expect that most of the assets currently in institutional, prime and municipal money market funds, would shift to government money funds, as many did with the last round of changes in 2016, or move to products like our private prime liquidity fund that are not subject to money market mutual fund regulation under 2a-7."
Donahue adds, "We have approximately $8 billion in client assets in this category of institutional prime and municipal funds that we believe would be impacted if swing pricing were to be imposed, as the SEC is proposing. We also commented that the SEC's proposed requirement that stable NAV money market funds convert to a floating NAV, if future market conditions resulted in negative money market fund yields, would lead to material outflows from US government money funds to bank deposits, or again, other non-regulated investment products. Now, taking a look at recent asset totals, managed assets were approximately $617 billion, including $413 billion in money markets, $87 billion in equities, $91 billion in fixed income, $22 billion in alternative private markets, and $4 billion in multi-asset. Money market mutual fund assets were $269 billion."
CFO Tom Donahue states, "Total revenue for the quarter increased 1% from the prior quarter, due mainly to lower money market fund minimum yield-related waivers, an increase of $34.3 million, and $2 million from higher average money market assets, offset by lower average equity assets, reducing revenue by $17.4 million, fewer days in the quarter, reducing revenue by $9.3 million, lower carried interest and performance fees of $3.6 million, and lower average fixed income assets, reducing revenue by $2.4 million. Q1 carried interest and performance fees were $100,000 compared to $3.7 million in Q4."
He comments, "Higher distribution expense resulted mainly from lower money market fund minimum yield waivers. Advertising and promotional expense decreased due mainly to the timing of our ad campaigns. With short-term rates higher in Q1, the negative impact on operating income for minimum yield waivers on money market funds decreased to about $18 million compared to $38 million in Q4. We expect the Q2 negative impact to decrease to about $1 million."
During the Q&A, Federated was asked about potential flows from deposits into money market funds. Money Market CIO Debbie Cunningham responds, "I think ... that deposit products, number one, don't follow interest rates in an upward fashion on a one-on-one basis. The deposit beta for the last time interest rates rose, was about 20%, meaning that for every 1% the Fed raises rates, deposits went up 20 basis points. The other side of that equation ... is that banks have more cash than they actually need at this point or want, and the demand for that cash is not high. So, they have no real incentive to attract cash by increasing their rates more quickly than they otherwise would. I think both of those pose to be problematic for those that are offering deposit-type products."
She explains, "On the other hand, when we look at what the yield curve is providing us with right now, what it may provide us with as investment opportunities next week after the Fed meets, we think that those are pretty substantial at this point.... You're going to see the return on money market funds following those Fed increases quite quickly.... But generally speaking, in a rising rate, as long as it's fairly well telegraphed ... you end up with money market funds following quite quickly in the path of rising rates and reflecting those higher returns back to customers."
On market share and the rate cycle, Chris Donahue says, "On the competitive thing, there have been several features. One is the normal amount of money that goes out for taxes. And I think we have more than the average bear. So, that was a factor. Another factor is, of course, the competitive landscape where others are waiving more than us, and our yields are where they are. That's what we've talked about before in terms of competitive situation. But overall, as you know, we don't end up losing clients on that score.... What we've seen is that when the rates get big and real, and they get caught up, ... the banks don't want the money and ... you get a spring back on the money fund assets."
Tom Donahue answers, "I don't have the '90s data, but back in '04 ... mid '04, the Fed raised by 25, and then a series of 50 basis point hikes through the next two years. Our assets initially decreased at that time. The fund assets went into that up-rate cycle at about $123 billion, went about $10-plus billion. Then came out of that with the last Fed movement up 50 basis points in mid '06, we were up pushing $150 billion. So, the cycle was about the same back in that timeframe."
Cunningham adds, "I'd warn against comparing to the '94 cycle, just simply because it was a very different Fed back in 1994, number one. But number two, there were a lot of other things going on in the market during that timeframe when there were unexpected 75 and 100 basis point increases in rates, and they were basically derivatives floating rate securities that were in the marketplace. Inverse floaters were what was happening then, 10-year CMT floaters, non-dollar-based LIBOR floaters. All of those things were causing angst in the money markets, and they've all been purged at this point. So, I think I would hesitate to compare to that time."
Responding to a question on consolidation, Chris Donahue says, "We like to look at it in terms of market share of revenues as another feature, not just market share of the assets, although market share of the assets is important. And so, when you talk about consolidation, my suspicion is, you'll have more of it, whether -- especially when you have the higher rates. People traditionally look at these things so long, and then they throw in the towel at some point. And as I've said here a lot of times, we're a warm and loving home for anyone who wants to get out of the money market fund business. I think we are well appreciated in the marketplace for that when people think it's time to throw in the towel on that."
Finally, Cunningham tells us, "One additional kind of positive aspect, what Chris was mentioning initially in the regulatory response to the proposed rule 2a-7 changes for the two most problematic proposals, those being swing pricing for institutional prime and muni, and FNAV for all products, including government and retail, the industry was pretty much joined in a voice saying, both of those things are not workable. I mean, there were a few outliers, but very few. I think that's a positive in that we attempt to work together for things that are really product and market-changing."
