Federated Hermes, Inc. (FHI) Q2 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Federated Investors Second Quarter 2015 Analyst Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ray Hanley, President of Federated Investors Management Company. Thank you sir. You may begin.

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

Thank you, Ray and good morning. I will briefly review Federated’s business performance and then Tom will comment on our financial results. I will begin by reviewing another strong quarter for our equity business. Against the challenging market environment was essentially flat equity market returns and industry net outflows from equity funds, our equity managed assets were up 1% from the prior quarter, and up 10% year-over-year and we had solidly positive equity net flows. Total net equity sales which includes both funds and separate accounts were $831 million, resulting in an annualized organic growth rate for equities of over 6%. Federated’s equity fund’s organic growth rate of 5.3% for Q2 annualized was again among the best in the industry. Based on Strategic Insight’s data, our second quarter equity fund’s net flows ranked in the top 3% of the industry. Our equity business is very well positioned with a variety of strategies producing solid performance and sales results. Using MorningStar data for ranks funds as of quarter end, seven Federated funds, 27% were in the top decile for three trailing years. We had 12 funds, that’s nearly half in the top quartile and about three-fourth of our funds in the top half for the trailing three years. Looking at the one year ranking, six funds were in the top decile, nine funds were in the top quartile and 16 funds were above media. Performance highlights includes Federated, Kaufmann Large Cap Fund in the top decile for the trailing one, three and five years. The Kaufmann fund is also top decile for one and three year marks, while the Kaufmann Small Cap Funds is top 13% for the trailing three years and top 3% for trailing one year. The International Leaders Funds, which is a Foreign Large Cap blend strategy, is top 3% or better for the trailing three, five and ten years. Four of our MDT strategies were top decile for the trailing three years including the MDT stock large cap value funds and the MDT all cap core fund. Our absolute return fund has developed a top decile one and three year record in the market neutral alternative category and the global allocation fund gives us another solid solutions-oriented strategy within its top quartile, one, three and five year record. These performance results highlights the breadth and strength of our equity product lines and position us for growth across multiple equity strategies. In the second quarter, 19 of 33 actively managed equity fund strategies had net positive sales led by, Kaufmann Large Cap, International Leaders, Kaufmann Small Cap, Capital Income, Muni Stock Advantage, Global Allocation, Managed Volatility and Absolute Returns Funds. Equity separate accounts net sales were driven by the domestic and international strategic value dividend strategies, MDT mid-cap growth and Kauffman Large Cap Growth. Equity fund net sales are slightly positive here early in the third quarter. Now turning to fixed income. Total net outflows of $276 million resulted from negative fund flows, partially offset by positive flows in separate accounts. As discussed last call, net fund outflows were impacted by tax-related seasonality in certain short duration products. We saw net funds inflows into the international, institutional, high yield bond funds and the total return bond funds. The high-yield trust and Sterling Cash funds also had solid inflows. At quarter end, we had ten fixed income strategies with top quartile, three year records, including high-yield, Munis, ultra-short, government and mortgage and short-intermediate total returns. Now looking at money markets. Assets decreased by about $6 billion from the prior quarter. This decrease does include the impact of tax seasonality. Money Market – money fund market share at quarter end remained at about 8%. We announced our plans during the second quarter for funds characterized as retail under the 2014 money fund rules and we continue to make progress on the institutional products line-up. We expect to provide more details on these products in the coming months. We expect, as we have mentioned before to have products in place to address the cash management needs of all of our money fund clients. These will likely include, prime and muni, money market funds that meet the new requirements, government money funds, separate accounts, and offshore money funds. We are also working on privately placed funds and in attempt to mirror existing Federated money market funds for our qualified institutional investors, either unable or unwilling to use the money finds that have been modified under the new rules. We expect to add substantially all of our product changes completed before the end of this year which is well in advance of the October 2016 requirements for floating NAVs or institutional prime and Muni funds. In April, we announced the deal with Reich & Tang Asset Management to transition money market assets into Federated Money funds. We expect about $4 billion to transition this month. We also recently completed the transition of about $100 million in money market assets from Touchstone Advisors. Interest levels and discussions around money market consolidation remains elevated. Taking a look at our most recent asset totals as of July 22. Managed assets were approximately $354 billion including $245 billion in money markets, $56 billion in equities and $53 billion in fixed income. Money market mutual fund assets were $212 billion. Looking at distribution, in addition to the Fund’s sales results, I have already covered, we had significant sales to successes for separate accounts. The SMA business continues to perform well. Total SMA assets ended the quarter at $16.5 billion with most of this in equity. Assets here are up about 14% year-over-year and nearly doubled over the last three years. Federated ranks seventh in the Cerulli Associates Rankings of the largest SMA Managers at the end of the first quarter which is the most recent data available. Interestingly, this business, SMA and Models which includes UMAs is now over a $1 trillion business. We also added about $250 million in institutional equity separate account assets from three wins that funded in the second quarter. These wins were in the MDT, mid-cap growth, Kauffman large cap growth and international leaders which is an EFA strategy. We recently won another EFA account for about $150 million which is yet to fund from a Canadian entity. Fixed income separate accounts added $477 million in net sales driven by new mandates and account additions in multi-sector, Muni, core, corporate and government bonds. We have had about $400 million in expected additions for fixed income to separate accounts yet to fund. On the cash side, we expect the West Virginia Local Government Investment Pool to fund at about $1.2 billion during the third quarter. RFP activity remains solid and diversified with interest in EFA products, Kauffman Large Cap, MDT, Clover, and dividend income strategies for equities and high yield and short duration for fixed income. Our RFP activity is up about 74% year-over-year. On the international side, we are planning product enhancements for Canada to accelerate the good growth that we’ve seen in the retail and institutional markets. We intend to launch a Canadian government domicile strategic value dividend fund product this year and as I mentioned, we were recently awarded a sizable EFA mandate in Canada. This is the $150 million expected in the third quarter. In Germany, during the second quarter, we added a high-yield mandate that reached $130 million and is expected to grow further. We recently won a $200 million corporate bond separate account, which is part of the $400 million expected in addition during the third quarter. We continue to seek alliances and acquisitions to advance our business in Europe and the Asia-Pac region, as well of course in the United States and the rest of the Americas. At this point, I would turn it over to Tom.

Thank you, Chris. Revenue was up 3% from the prior quarter and 7% compared to Q2 of last year, mainly to higher equity assets which added $7 million of revenue versus Q1 and $15 million versus Q2 2014. Money market related revenues also increased with improvements in waivers largely offset by lower assets. Equities contributed about 48% of Q2 revenues, again the highest percentage among the various CapEx process. Combined equity and fixed income revenues were 69% of the total. Operating expenses declined from the prior quarter, due mainly to lower comp and related expense.. Comp decreased due to lower incentive compensation expense which was impacted by lower fund sales and personnel changes. Other factors included seasonally lower payroll, tax expense and lower stock compensation expense. Q3 comps and related estimates is about $72 million. The pre-tax impact of money fund yield waivers of $22 million was down from the prior quarter and from Q2 of last year. The decreases were due to both higher fund yields and lower fund assets. Compared to the prior quarter, about 75% of the improvement was due to higher yields and 25% from lower assets. Based on current assets in yields, the impact of these waivers to pre-tax income in Q3 would be about the same as Q2. Looking forward, we estimate that gaining 10 basis points in gross yields from beginning Q2 levels would likely reduce the impacts of yield waivers by about 40% and a 25 basis point increase would reduce the impact by about 65%. We expect to recover about two-thirds of the remaining money fund yield waivers related pre-tax income. Multiple factors impact waiver levels and we expect these factors and their impacts to vary. These factors include changes in fund assets, available yield for investments, actions by regulators, changes in the expense levels of the funds, changes in the mix of customer assets, changes in product structure, changes in distribution fee arrangements with third-parties, Federated’s willingness to continue to see waiver and changes to the expense to which the impact of the waivers is shared by third-parties. The effective tax rate was approximately 38% and that continues to be our expectation going forward. Looking at the balance sheet, cash and investments total $300 million at quarter end. We would not like to open the call up for questions.

Thank you. At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question is coming from the line of William Katz with Citigroup. Please proceed with your question.

Thank you. The next question is coming from the line of Michael Kim with Sandler O'Neill. Please proceed with your question.

Thank you. The next question is coming from the line of Ken Worthington with JPMorgan. Please proceed with your question.

Thank you. The next question is coming from the line of Craig Siegenthaler with Credit Suisse. Please proceed with your question. Craig, your line is now live. You may proceed with your questions.

Thank you. The next question is coming from the line of Surinder Thind with Jefferies. Please proceed with your question.

Thank you. The next question is coming from the line of Greg Warren with Morningstar. Please proceed with your question.

Thank you. Our next question is a follow-up coming from the line of William Katz with Citigroup. Please proceed with your question.

Thank you. It appears there are no further questions at this time. So I’d like to turn the floor back to Mr. Hanley for any additional concluding comments.

Okay, well, thank you. That concludes our call and we appreciate you joining us today.