FII
#Good morning.
Thank you, and welcome.
Leading today's call will be Chris <UNK>, Federated CEO and President; and Tom <UNK>, Chief Financial Officer.
And joining us for the Q&A is Debbie <UNK>, 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, <UNK>ay, and good morning all.
I will briefly review Federated's business performance, and then Tom will comment on our financial results.
Looking first at equities.
With favorable markets and solid investment performance, we closed Q1 with record high equity assets of just under $65 billion.
Total assets in the domestic and international strategic value dividend strategies increased 4% in the first quarter to reach a record high of $38.9 billion.
The strategic value dividend fund's investment performance was solid in the first quarter, returning 5.3%.
This ranks it in the top 9% of funds in the Morningstar category, which it has been assigned, namely Large Cap Value.
We have emphasized in the past that this fund pursues a strategy different than many of the funds in this category and has moved regularly between the first and fourth quartiles over its history.
In fact, looking at the fund's quarterly returns since its 205 inception, it has been either in the first or fourth quartile 92% of the time.
And the time spent in the first quartile and the fourth quartile has been split evenly.
So the fund ranked in the top 13% on a trailing 3-year basis at quarter end, the top half for 5 years and the 98th percentile for the trailing 1 year.
Importantly, for the fund's objective of producing a high and growing dividend income stream from high-quality companies, the fund's 12-month distribution yield of over 3% ranked in the categories third percentile at quarter end.
Now while the $14 billion fund had first quarter redemptions net of $630 million, net redemptions were lower for each month of Q1 compared to December.
The $21 billion SMA strategy had Q1 net redemptions of $28 million.
Net sales for all equity funds in separate accounts in Q1 were negative at minus $1.4 billion.
However, funds with positive net sales in the first quarter included MDT Small Cap Core, MDT Small Cap Growth, Clover small value, Pru Bear and the Muni stock advantage fund.
Using Morningstar data for trailing 3 years at the end of the first quarter, 2 Federated funds were in the top docile, 8 funds or 31% were in the top quartile and 42% were in the top half.
The trailing 1 year were even better with 9 funds or 32% in the top quartile and 16 funds or 57% above medium.
On a Lipper basis, 3/4 of the assets that they rank on our equity funds are in the top half over a 3-year period.
In addition to Strategic Value Dividend, other top quartile trailing 3-year equity strategies at the end of the quarter included the MDT Small Cap Core, Small Cap Growth, Kaufmann, Kaufmann Small Cap and Muni stock advantage.
Three weeks into the second quarter, net sales of equity funds and SMIs ---+ SMAs combined are negative at about the same rate as the first quarter, while the Strategic Value Dividend Fund in April is on a similar pace to Q1's net redemptions.
The Strategic Value Dividend SMA had positive early second quarter net sales.
Turning now to fixed income.
Overall, Q1 net redemptions were minus $326 million with positive fund net sales of $155 million offset by negative net sales from separate accounts of $481 million.
Net fund sales were led by high yield, the floating rate fund and the Total <UNK>eturn Bond Fund.
On the separate account side, we added a $62 million high-yield account and added $15 million Trade Finance win fund into our new Trade Finance tender offer fund instead of a separate account.
We also had a $126 million of wins from last quarter that had not yet funded by the end of the first quarter.
Net redemptions for separate accounts were primarily due to institutional account outflows due to model and asset allocation changes and redemptions driven by the clients' use of cash.
Our fixed income business has a variety of strategies that are performing well.
At quarter-end using Morningstar data, the Institutional High Yield Bond Fund was in the top 6% for the trailing 3 years, top 11% for the trailing 5 and the top 5% for the trailing 10 years.
Our Total <UNK>eturn Bond Fund was top quartile for the trailing 1, 3, 5, 10 and 20 years.
In total, we had 9 fixed income strategies with top quartile 3-year records at quarter-end.
Others include Floating <UNK>ate Strategic Income and Ultrashort bond.
Fixed income net sales for funds are slightly negative early in the second quarter.
Now looking at money markets.
Total assets in the funds and separate accounts decreased by $7 billion from Q4.
The previous discussed transition of a $21 billion money market fund to a subadvised separate account impacted the reported assets by product type.
Excluding this transaction, money market mutual fund assets decreased by about $10 billion from Q4, and separate accounts added about $3 billion.
Our money market mutual fund market share at the end of Q1 was 7.5%, about the same at the end of 2016.
Money fund assets remain concentrated in government funds.
We believe that as spreads widen, investors who exited prime funds will over time consider and reconsider their options, including our recently launched private prime fund and our collective prime fund.
We also believe that a rising rate environment will be positive for money market funds and will encourage investors to shift some money from bank deposits.
Our prime collective and prime private funds had about $460 million in assets at the end of Q1.
Taking a look at our most recent asset totals as of April 26.
Managed assets were $262 billion, including $245 billion in money markets, $65 billion in equities and $52 billion in fixed income.
Money market mutual fund assets were $174 billion, about the same as the average so far in April.
Looking at distribution.
Q1 was another solid sales quarter for our SMA business with over $1.9 billion in gross sales and $16 million in net sales.
Total SMA assets ended the quarter at an all-time high of just over $25 billion, an increase of $6 billion or 33% since Q1 of 2016.
Federated ranked fifth in the [MII Dover] rankings of the largest SMA managers at the end of 2016.
In the institutional channel, we recently won mandates in high yield and Strategic Value Dividend.
We began Q2 with about $500 million in separate account wins yet to fund, including approximately a $126 million of wins from last quarter not yet funded.
This is offset by the amount of expected separate account redemptions.
We also had an institutional win in Q1 for our Trade Finance strategy that should fund for about a $125 million later this year in our Project and Trade Finance Tender Fund.
<UNK>FP and related activity continues to be solid and diversified with interest in MDT Small Cap and other strategies for equity, high yield and short durations.
We are prepared for the changes in the landscape related to DOL fiduciary rules.
We have 26 funds with <UNK>6 pricing, 56 funds that fit the definition of clean shares.
We put the offering of our T Shares on hold pending the delayed application of the DOL fiduciary rules and final direction from intermediaries.
We are well positioned with our $25 billion SMA business with 14 equity strategies and 8 fixed income strategies.
SMAs worked very well in a level fee wrap account structure offering transparency and potential tax advantages.
Federated, as we've mentioned before, has extensive resources and institutional knowledge and experience to assist intermediaries to navigate the changes that come directly or indirectly from the new fiduciary rules adopted or not adopted.
We have helped bank trust departments with these same challenges for decades.
We see this as an opportunity to add significant value for our clients and recently launched a new website called fiduciaryluminary.com as a value-add program for advisers on managing their practice as a fiduciary.
On the international side, we recently announced the addition of a new business development team for Asia-Pac.
The effort is led by Bill Taki, who joined Federated as the CEO of our Federated Investors Asia-Pac project.
Bill has broad and deep high-level relationships in the region cultivated over 34 years of experience in business development.
The 4-member team will focus on the regional distribution of Federated's investment strategies and growing strategic relationships with financial institutions.
The new effort for Asia-Pac complements our European, U.K. and Canadian operations.
In Canada, with last year's rollout of the new Canadian-domiciled Strategic Value Dividend Fund, assets are approaching $2 billion, up from $1.6 billion at the end of 2015.
We continue to sync ---+ seek alliances and acquisitions to advance our business in Europe and the Asia-Pac region, as well, of course, as in the United States and the rest of Americas.
Tom.
Thank you, Chris.
<UNK>evenue was up 1% compared to Q1 of last year due to lower yield waivers and higher revenues from equities, largely offset by lower money market-related revenues, which included the impact of the previously discussed change in a customer relationship.
The revenues decreased 6% from the prior quarter due largely to the same change in the customer relationship and to fewer days.
Q4 revenues in 2016 also included approximately $3 million related to a nonrecurring fee credit from a fund service provider.
These amounts were partially offset by lower yield waivers.
Equities contributed 41% of Q1 revenues, and combined equity and fixed income revenues were 58% of the total.
Operating expenses decreased 1% compared to Q1 of last year and decreased 5% from the prior quarter.
The decrease from Q1 of '16 was due mainly to lower comp and related expense reflecting lower incentive comp accruals and lower professional service fees.
This decrease was partially offset by an increase in distribution expense and lower yield waivers, and higher equity and fixed income assets.
The decrease from the prior quarter was due mainly to lower distribution expense reflecting the change in a customer relationship, lower average money market assets and 2 fewer days.
In addition, Q4 distribution expense included a $2 million expense to correct certain underpayments of past distribution costs.
This decrease was partially offset by higher comp and related expenses.
Comp and related for Q1 was impacted by seasonality and a reversal of approximately $2 million of incentive comp accrued for 2016 but not paid.
And early estimate of Q2 comp and related expense is about $72 million.
As previously discussed, the customer relationship change near the end of January resulted in a decrease of approximately $1 million of pretax income in Q1 and is expected to impact Q2 by an additional $1 million or $2 million total when compared to Q4 2016.
The pretax impact of money fund yield related with fee waivers of $800,000 was down from the prior quarter $3.4 million and Q1 of last year, $9.4 million.
The decreases were due mainly to changes in the customer relationship, higher gross yields and lower fund average assets.
Based on current assets and yields, we expect the impact of these waivers on pretax income going forward to be immaterial.
Our effective tax rate for the quarter was about 37%, and we expect the same rate for Q2.
At quarter-end, we had cash and investments of $278 million, of which $247 million is available to us.
We continue to be active in the share repurchase program purchasing 513,000 shares in the first quarter.
Tanya, we would now like to open the call up for questions.
They would signal, Bill, more of a de novo effort than M&A.
But one of the ideas is to try and duplicate the kinds of relationships we have with LVM in Germany, where you develop a good, strong relationship with the large institutions, which would mean money being managed by us in all kinds of different mandates, all the way from cash to high yield to total return bond and some global stuff on the one hand and then some retail connections on the other side.
So it's a search for big-type partnership relationships that we can grow from.
Thank you, Bill.
Let's ---+ I don't usually get into daily numbers.
But on the Strategic Value Dividend, the gross sales so far this month have averaged about $10 million a day, and the redemptions at the beginning of the month were a lot closer to $25 million a day.
And now they are down to numbers like $12 million and $13 million a day, which means that the net sales are threatening to go even par for the tournament.
And what you're seeing here in some of our guesses is the roll off of those assets that came in because this fund was purchased not with the idea of a dividend and a growing dividend, but last January, when it was declared to be the world's #1 fund in every condition.
And so I think we're seeing a very much diminishing of the net redemption picture on that fund looked at so far this April on a daily basis.
And that is the largest thing going on in terms of redemption profile here.
The second one is the Kaufmann Fund, and that has, over the years as you know, been a negative sales producer at Federated.
However, with the outstanding performance of that fund over the recent time frame bringing its numbers up for 1, 3 and 5 years into the top quartile, we're starting to see some diminution in those net redemptions as well.
So it is the performance that over the long haul is going to drive the truck.
And once that gets decanted into the marketplace, we have a lot of confidence that we have the mandates with the performance to get back on to a positive flow.
The $3 million was a Q4 item.
It was a revenue item, where we got a refund of past fees.
So that's a onetime item.
And Bill, on the fixed income, as we said, they're slightly negative.
High yield is very slightly negative.
Of course, that has been solidly positive for several quarters and years.
The institutional fund actually is a little bit positive, but the retail portion has flipped to slight outflows.
Still positive on floating rate and on Ultrashorts.
Very slightly negative on Total <UNK>eturn Bond, despite the outstanding performance profile that Chris went through.
So we had a lot of confidence that, that will flip back to where it's been as well.
Okay.
We'll divide this into 3 questions.
In terms of the 2 economic ones, namely on the prime funds and the collective funds, I'll do that one and then also on the economics of the SMA, and then <UNK>ay will take care of the other question.
So on the relative economics of the prime and the collective funds, it's basically the same as the other money market funds.
Now obviously, these funds are smaller, meaning together they're $460 million.
But we're trying to grow, I mean, working hard getting a money market fund up to a size where people are willing to take a big position is part of the challenge.
And that's why I mentioned that both higher rates gross and higher spreads net are going to be important ingredients as we present those products to the marketplace.
But basically, it's the same drill whether you're in one of our other money funds or in those.
Then on the SMA, depending on whether it's SMA or UMA, the basic pricing is about ---+ is half or a little less than half of the pricing on the mutual fund.
And the reason for that is that, obviously, the account sizes are way different, much higher, but you're fitting into a mechanism on the broker/dealer or the adviser side, where they are charging a fee for the flat service, and you do not have all of the expenses associated with running a mutual fund.
And so that's about the difference there.
<UNK>ay, you want to handle the third one.
Sure.
Ken, without commenting on the specific separate accounts just generally and fund rates, on the first ---+ in the first quarter, if you take our total money market fund business on a net revenue basis, net of the distribution expenses, it comes out to roughly around 10 basis points, a little above 10 basis points.
And on the institutional separate account side, that's more like around a 4 basis point rate, which is dominated by a handful of very large ---+ very, very large accounts.
But in terms of individual separate accounts, they're essentially priced on an individual basis.
Well, obviously, there's a huge change in the amount of money that went into govies.
And there were some participants who over that time frame reduced their pricing.
And that was a factor that we've talked about on these calls before.
In terms of the prime, because some people shut their primes down and because of the requirements of those October 14 implemented October 16 amendments, it's difficult to get that money back in.
Over $1 trillion left the industry.
I'm not aware of people doing a lot of shenanigans on the prime side with those assets.
But I would ask Debbie to give you an up-to-date version.
Certainly on the government side, as Chris mentioned, there have been a few in the market that have chosen strategically to lower fees and captured some of the assets that were flowing out of prime and into government.
I would say year-to-date 2017, that has been less of an issue or it's more of an issue in the third and fourth quarters of last year.
And maybe 1 or 2 smaller ones are still in that mode in the year-to-date 2017 standpoint, but it's not necessarily prevalent as much is it was just 2 quarters ago.
From a prime standpoint, we're not seeing that.
I think those funds are now at this point enjoying a yield curve that is fairly steep and has a lot of spreads associated with it versus treasury and government agency yield curves.
And at this point at least, it's more a battle of how do you get asset size not from a fee waiver perspective but just getting clients comfortable with the new product, with the structural changes that went into those products.
It's not being done through a fee waiver standpoint.
Well, it's interesting.
From a history perspective, generally in a rising rate environment, money funds lose assets to the direct market, whether it's repo or deposit instruments.
We're not seeing that so much in this case, but we're not seeing a whole lot flow back in.
In fact, we're trying to emphasize though at this point the attractiveness of funds versus bank deposits, the average bank deposit rate, which is a difficult thing to come up with and it is a varied range, but the average that we can find at this point is right around 53 basis points.
Our government funds are yielding 80-plus basis points.
Our prime funds are yielding about 20.
There's easily 30 to 70 basis points in spread over bank deposits, and I think it's just an awareness.
Now granted that 53 basis points, like I said, some ---+ I found a few that are out in the 1%, 105, but quite a few that are still down at a basis point.
So it's an awareness.
And I think, again, a comfortability with the new product set as it's been changed from a regulatory standpoint by the SEC back in October of last year.
That's our challenge at this point.
We do not, <UNK>ob.
We've looked at it ---+ you could double these funds looking at it from the whole strategy of $38.9 billion.
And we've looked at it in terms of whether you can get the positions we want, the liquidity on exit, if you had to the VWAPs and purchasing exercises if you go through to take positions, and we just don't see limitations on the size of that.
And it is in part because of the large cap stocks that are in there.
The other thing that we have done anyway, but it's as much a strategic diversification as anything is to create an international version, a global version, sell it over in Canada.
And this does expand the percentages of some of those foreign stocks that you're able to put into the overall mandate, which is a little bit helpful.
Yes.
Mike, it's <UNK>ay.
I'll just comment on the fee rates in the same way we did on money markets.
If you take the equity mutual funds in the first quarter ---+ and again on a net revenue basis, net of the distribution revenue and related expense that kind of passes through, that would get you to about 75 basis points.
And if you take the separate accounts in total, and of course, they're dominated by strategic value and by SMA, it would run about half of that.
And that's a rather typical relationship, I think, in the industry separate accounts fees compared to mutual funds fees where, of course, the services are quite different.
Mike, on the margin, even the unwinding the change actually the relationship really didn't impact the margin very much just as a ---+ the margin had nothing changed would have been very, very close to what it was.
So you should not expect to see the full follow through on a full quarter basis to move the margin.
Well, that concludes our comments for today, and we thank you for joining us.
