Good day and welcome to the FHI Q4 2022 Analyst Call and Webcast. At this time, all participants have been placed on a listen-only mode. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Ray Hanley, President of Federated Investors Management Company. Sir, the floor is yours.

Good morning, and welcome. Leading today's call will be Chris Donahue, Federated Hermes’ CEO and President; Tom Donahue, Chief Financial Officer. And joining us for the Q&A are Saker Nusseibeh, who is the CEO of Federated Hermes Limited; and Debbie Cunningham, our Chief Investment Officer for Money Markets. Today's call, we will make forward-looking statements and we want to note that Federated Hermes' actual results may be materially different than the results implied by such statements. Please review our 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, and good morning all. I will review Federated Hermes' business performance, Tom will comment on our financial results. We ended 2022 with record total assets under management of 669 billion. This was driven by growth of 35.6 billion in money market assets in Q4 to reach a record high of 477 billion at year-end. Turning to equities. Assets increased by about 7 billion to 81.5 billion due to market gains, FX impact, and net positive sales in separate accounts, all of which were partially offset by net fund redemptions. The strategic value dividend strategy continued to produce solid net sales with nearly $1 billion in the Q4 with about a quarter of that from the fund, and almost three quarters of that from the SMA. The U.S. Strategic Value Dividend ETF launched in mid-November now has 42 million in assets. We saw Q4 positive net sales in 16 equity fund strategies, including Asia ex-Japan, International Strategic Value Dividend, MDT Large Cap Growth, European Alpha Equity, International Growth and Clover Small Value. Q4 equity fund net redemptions of [1.4 billion] [ph] were concentrated in our growth strategies. Our equity fund performance at the end of 2022, compared to peers was solid. Using Morningstar data for the trailing three years, at the end of the year, 61% of our equity funds were beating peers and 33% were in the top quartile of their category. As we begin 2023, our equity focus with clients continues to be on the strategies that have responded well in inflationary times. These include dividend income, international, emerging markets, and value. Now, for the first three weeks of Q1, combined equity and SMAs had net positive sales of 328 million. We had 23 equity funds with positive net sales during this period, including Strategic Value…

Thanks, Chris. Total revenue for Q4 decreased 7.2 million or about 2% from the prior quarter due mainly to lower average long-term assets and lower performance fees in carried interest, partially offset by higher average money market assets. Q4 performance fees and carried interests were 3.3 million. Q4 operating expenses increased 25.8 million or 9%, compared to Q3, driven by the 31.5 million non-cash intangible asset impairment charge, offset mainly by FX impact of 8 million from the currency forwards used to hedge certain pound exposure. The impairment charge was due to the change in fair value of one of the intangible assets from the 2018 Hermes Fund Managers Limited acquisition, representing about 6% of the total acquisition price. The lower asset valuation was driven by changes in projected cash flows and a higher discount rate, compared to the prior quarter. In non-operating income, investment gains after subtracting the impact attributed to the non-controlling interest added earnings per share for the quarter of about $0.04, due to the positive impact of the market on the investments. Looking ahead to Q1, certain seasonal factors will impact results. The impact of fewer days is expected to result in about 6.4 million in lower operating income, excluding the impact of the impairment charge and with all else being equal. In addition, based on an early assessment, compensation and related expense could be $13 million higher than Q4, due primarily to about 9 million of seasonally higher expense for stock compensation and payroll taxes. We also expect to have higher base pay, higher incentive compensation expense, and of course, all these amounts will vary based on multiple factors. The effective tax rate was lower in Q4, primarily related to a one-time recognition of a capital loss for tax purposes. Non-taxable, non-controlling interest income that's included in our pretax income, but non-taxable to Federated Hermes and certain stock based compensation where we get a higher tax deduction when our stock price investing exceeds the price when the shares were granted. We expect our effective tax rate to be in the range of 24% to 26% in 2023. At the end of 2022, cash and investments were 522 million of which about 466 million was available to us. [I] [ph] would now like to open the call up for questions.

Certainly. [Operator Instructions] Your first question for today is coming from Dan Fannon at Jefferies. Dan, your line is live.

Hi, good morning. This is actually Rick on for Dan. Just thinking about expenses, how should we think about the general trajectory for non-comp expenses? And also, kind of double clicking into that, I believe the other line, excluding the impairment charge was lower by approximately 5.5 million or around that range, compared to the last three quarters and a year-ago. Just wondering was that, sort of the FX impact, FX impact in the other direction that was called out or is this, sort of [run rate] [ph] savings?

Yes. I'll cover some of those, Ray will come in with a few more. So, I mentioned the comp already. So, all else being equal, we expect that to go up. Distribution, we would expect that to go up. We see that as the old days as success item, as we get more assets, distribution goes up, systems and communications, professional service fees, travel related, those all have inflation and price increases. All are expected to go up. And you would comment on the other?

Yes. Rick, you're correct with the FX impact, and obviously, we saw pretty significant movement in the pound in Q3. And so, we had a net expense in that line item. And then for Q4 with the pound moving the other direction, we had a net credit that was the $80 million that we mentioned.

Got it. Appreciate that color. And then just on, sort of the higher expenses that you called out, could you point to maybe a pre-pandemic, sort of year or set of quarters that we can look at for general levels as a percent of revenues or is there a better way to think of that?

Yes. So, we don't look at it like that at all. We just don't calculate it based on that way and don't think that way. We're trying to raise assets what's the best way to do it. And, like for T&E, the sales force believes they should be out there and you can see that trending up, and it's trending up and they're out there traveling more and it costs more to do it. But we don't calculate the way you're talking about.

Understood. Appreciate that. And if I could sneak one last question in there. In terms of long-term fee rate, just – and sort of the quarter to date, kind of flow discussion that was called out, how does the exit rate for the fourth quarter, kind of compared to the average? And how does that look like going into early January?

The fee rate really is a function of the blend of changes in assets. And so, you've seen, for example, in equity over the course of 2022 with growth assets being down, to say one example that would be a case where we would have higher than the average – higher than our average fee rates. In addition, we've had growth in – we called out the strategic value dividend, SMA. And SMAs of course have lower management fee rates than the mutual funds do. So, it's really a function of the blend of where the average asset growth is occurring and looking at the first couple of weeks of 2023, I would say, we're not going to see, I wouldn't use that to forecast any material change in the fee rate. We'd want to cover some more ground before doing that. And they're good solid wins in categories like high yield, multiple, most of the equity products producing net positive flows. And of course, we've had positive market impact. So, all of that goes to the good.

Thanks guys. Really appreciate the color.

Your next question for today is coming from Patrick Davitt at Autonomous Research. Patrick, your line is live.

Hi, good morning everyone. So, my first question is on the Hermes impairment, could you give a little bit more detail on the changes that went into the cash flow downgrades? Are there some products that are not working out as planned? And I guess more broadly on that point, has your view on the opportunity for growth there changed in some way?

Yes, Patrick from Autonomous. The cash flows, we have to go through, I think there's six different categories when we did the deal, and this is one category, the public markets. And since the deal, if you look at it from a – since 2018, the assets and particularly more recently, the asset declines, and then we have to go through and look at forecasts and predicting the future. We just had to scale those back and then the discount rates of course rates have gone up since we did the deal. And so, when you, kind of take the whole picture on a long-term basis, we had to have an impairment just on an accounting basis, pretty simple.

In terms of excitement with what's going on, with Hermes, I think number of things that Chris mentioned in our pipeline are pretty exciting. And I think Saker out to give a comment on exciting things that we still see happening there.

Thank you very much, Tom. So, I mean, let's start just with some of the stuff that you heard from Chris. If you remember, he said that $4.8 billion of net [institutional managers] [ph] are yet to fund, but these are signed and yet to fund. And the majority of these actually are coming into Federal Reserve and is limited, which is in London. With old Hermes business. And that gives you an idea of the strength of growth. And of that, for example, if you talk about the equity strategies well over a billion, 1.3 billion is in Asia ex-Japan. Then you've got further [270 odd million] [ph] going into global emerging markets, another [117 odd million] [ph] going into global equities and then some more into fixed income and [indiscernible] you look around 290 million, add to which you can add private equity, which is over 1.3 billion and you have a very exciting picture based on the future positivity that we see. I mean, yes, one [indiscernible], but it tells you the strength that's here we're looking forward. Now why is that? Two reasons. One is, yes, of course, since 2018, from an accounting perspective, we've got to look at the fact that markets went down, there was COVID and there was the Ukraine war and we have a lot of growth assets or growth equities in our public markets, but actually, they are much in demand. We've seen that even through the [couple of] [ph] last years, and it looks as if this is going to continue to grow for us. The proof of the [pudding] [ph] is within public markets is, we're continuing to invest particularly in sales. We're looking at offices in other parts of Continental Europe than the ones we've got. We've talked…

Helpful. Thanks. Just a quick follow-up. Could you give the performance fee number for the quarter?

It's 3.3 million.

Thank you.

That’s performance fee and carried interest.

Got it. Thank you.

Your next question today is coming from Mike Brown at KBW. Mike your line is live.

Great. Good morning. Want to start on the – maybe on the balance sheet here. So, I guess the buybacks were lower in the quarter, but I did notice that your cash position has grown, meaningfully it stands at more than 25% of assets. So, how are you thinking about your cash levels and capital allocation more broadly, could we see a return to buybacks or a special dividend here?

Well, yes, cash has grown. It's spectacular since we raised the long-term debt at what we view a very favorable rate and we bought back pretty significant amount of shares. And we historically have not wanted to hold on to cash. Now, starting new products has become more expensive i.e. more investing is needed. So that's, kind of a demand for resources to have seed assets, but on a long-term basis, we have not been a group to hold on to the cash. So, we will see, we want to do acquisitions that's been our first desire with the use of the money because of our returns on them. And we of course have the regular dividend. As you know, we paid five special dividends, and we bought back a lot of stocks. So, all of those are on the table for us to figure out what to do with the cash with no timetable and not trying to lead you to – we're going to do this through this through this.

One other point I'd mention here is that even though earnings are down on a kind of impairment, we still have cash available to do a lot of the things, Tom said, which I would phrase as investing for the future. And this means putting money into the platform in the private equity area over the UK. It means $140 million worth of commitments in technology that it doesn't hit income in any one-year as you all know. And Tom mentioned the fact that investments in seed assets those are running at about 140 million, again the same number obviously not related. And so, those are – were the interest of cash, but they all point to building for the future.

Great. Thank you. And then if we could just switch gears to the flows. The ultrashort fixed income flows, can you just expand on what drove the outflows there? What’s some of the investor dynamics that would cause that to happen? And then on the money market side, it sounds like you're basically just down a little bit in totality from the 4Q EOP levels, but the mix has shifted a little bit. Any additional color you can put around that? What's – we're kind of driving the growth of the SMAs? And is that more sticky than the fund side, which sounds like it benefited from some seasonality in 4Q?

I can start to answer those questions. From an ultrashort perspective and it definitely pertains to where we are from an interest rate standpoint in the marketplace. Interest rates continued to go up in the fourth quarter by 75 basis points and then again 50 basis points in December. The expectation is, they'll continue to go up more modestly, but hold at a higher level in 2023. And when you see that sort of increase in rates in the marketplace generally, anything outside of liquidity products, i.e. money market products or cash are going to see flows going in the opposite direction. Those flows can come out of the institutional side, the retail side, corporate. So, there's generally speaking, a broad-based exit that has slowed down as the year has progressed. And in products even like Microshorts that got money in that basically is offsetting some of what we're seeing in the, sort of little bit further out the yield curve, the ultrashort types of products. From a money market fund perspective, the mix continues to be obviously predominantly in the government sector. However, where we experienced on a percentage basis, the most amount of growth during 2022 was in the [prime and muni] [ph] sectors and that's simply a result of being above zero at this point and therefore the spread between government and those other categories widening out as interest rates themselves have increased. When you look at it on a quarter-over-quarter basis, the fourth quarter always has a huge amount of inflows not always, but for the most part has a large amount of inflows in the second half of December, let's call it, it’s window dressing, as well as tax purpose issues that many firms are trying to do and ultimately this results in inflows into the government in particular money market funds during the second half of December, some of which then goes out, generally the first quarter of 2023 sees outflows out of those products. Because of increasing interest rates, however, the other categories prime, in particular, has continued on a percentage basis to offset those flows in a pretty decided way.

And Mike, just on the separate account growth into January, you mentioned some seasonality there and that does come into play. That category of asset for us is dominated by large state cash pools that we manage. And so, it has a regular pattern of increasing when tax receipts are made at year-end, you know through the middle of the second quarter typically and then that tends to go down over the latter half of the year, but it's fallen, it's reached higher highs and higher lows. We've had a lot of underlying success both because of a favorable macro for money market yields and also some effective work that we've done with those clients to increase utilization of those pools.

Okay, great. Thank you for taking my questions.

Your next question for today is a follow-up question coming from Patrick Davitt. Patrick, your line is live.

Hey, thanks for the follow-up. Just on the back of that question, I asked a similar question last quarter, but you – we keep hearing from some of your competitors that there is an expectation of a bigger surge into money fund flows from say deposits. And I know there's always some seasonality noise from December to January, but are you still at the view that that big rotation is coming this year and what milestones are you really looking for, for that to really pick up?

Sure, Patrick. Generally speaking, when interest rates are increasing because money funds have a weighted average maturity that's something greater than a day. They lag the direct market, and so for many of our institutional clients that have the capability of going into the direct market, they might do just exactly that rather than go into money market funds that are increasing, but are increasing with, let's call it, a one-month lag versus the direct market, where money funds generally start to excel and exceed from a growth perspective is when interest rates have, kind of reached a plateau and when they start going back down the other side. Now, the caveat to that is that they're not going to zero, that they're going from 5 to 4 to 3, somewhere in that neighborhood. And in those cases, that's when much more outsized growth generally happens from an industry and from our own experience here at FHI versus the deposit market at this point. Overall, deposits in the U.S. are down about a trillion dollars, but they're still very large. And again, looking at the rates on deposits versus the rates on money market funds, they have increased during the first quarter, we're up to about 38% from a deposit beta perspective versus what's happening in the direct market, the Fed funds market. So, 38% of the increase is being captured in deposits. As such, I think that the average deposit rate for the fourth quarter was up to about 70 basis points, but compare that to where we are from a fund yield perspective, which is essentially all north of 4% and heading towards 5% vastly different. So, being a trillion down in deposits is just, sort of a drop in the bucket. The expectation would be that we'll continue to fuel outflows with that deposit beta being lower and a very natural recipient of those outflows would be money market funds.

And if I can indulge this history, which I've used before, Patrick, I think it's informative. The Fed increase that was Q4 2016 to Q4 2018, we had a little pause and then the money – our money market assets increased by 15% from about 210 billion to 240 billion, and the industry followed a very similar pattern. They were up 11%, naturally we were up 15%. Then you go to the next one. Our assets went up about 22% through the third quarter of 2019, and the industry at that time did about 14%. So, depending on how big people are talking about numbers, that those are what happened. The next point I would make is that it matters a lot who your clients are and what is their history. And we have unique clients, others have unique clients and I can't comment on the overall situation with others clientele. And actually, we have a lot of the same ones, but it matters a lot, if you have a lot of trust departments, a lot of intermediaries and things like that.

Very helpful. Thanks.

There appear to be no further questions in queue. I would like to hand the call back over to Ray Hanley for any closing remarks.

Well, thank you. That concludes our call and we appreciate you joining us.

Thank you. This concludes today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.