Federated Hermes Q3 Analyst Call & Webcast - FEDERATED HERMES INC

Financial Performance:

• Total revenue increased $4.6 million (1%) year-over-year, driven by equity asset growth ($8M) and additional days ($5.3M), partially offset by lower money market average assets (-$4M).
• Q3 operating expenses decreased $15.9 million (4%) to approximately $383 million, due to $11.2M lower transaction costs from the FCP acquisition, $3.3M lower compensation, and reduced intangible asset amortization; these were partially offset by $1.9M withholding tax expense and a $1.7M adjustment to FCP contingent payment.
• Carried interest and performance fees totaled $726,000, down from $1.4 million in Q2, with approximately $428,000 offset by compensation expenses.
• Q3 effective tax rate was 27.1%, with a full-year 2026 guidance of 25%–28%.
• Cash and investments stood at $580 million at quarter-end, with $483 million excluding non-controlling interests.

Guidance and Future Outlook:

• Q4 through October 23rd net equity sales guidance is $7 billion in MDT additions; private markets expected to see $1.2 billion net inflows (direct lending, PE, trade finance).
• Fixed income is expected to face $1.7 billion in net redemptions in Q4, largely driven by client risk-profile shifts in the Total Return Bond strategy.
• Institutional pipeline of ~$6.5 billion is expected to fund over the next two quarters, primarily in equity strategies and sub-advisory mandates.
• Management anticipates compensation expenses to rise in Q4 due to growth, while distribution expenses will track money market asset performance.

Business Segments and Product Lines:

• Equity: AUM reached a record $110.5 billion (+$949M); MDT strategies led with $6 billion gross sales and $3.2 billion net sales. 56% of equity funds beat peers, with 33% in the top Morningstar quartile over three years.
• Fixed Income: AUM at $99 billion; net sales of $700 million were offset by $1.8 billion in market value declines. Sterling Cash Plus Fund and short-duration products led inflows; 49% of fixed income funds beat peers.
• Money Markets: Total assets declined $27 billion (4%) to ~$890 billion, impacted by Fed rate hikes and corporate tax payments; Q4 early signs show a $3.7 billion rebound. Market share held at 6.6%.
• Private Markets: Assets rose slightly to $21.7 billion; launched new funds including the European Real Estate Debt Fund and 6th vintage PEC Series.
• Digital Assets: Announced partnership with Prometheum to expand tokenized securities distribution via FINRA-registered infrastructure; engaged with BNY, ARCEX, and Conduit for global tokenization initiatives.

Market and Competitive Landscape:

• Money market flows in Q3 were seasonal and idiosyncratic, with competitors like BlackRock and JPM experiencing inflows while Federated Hermes saw outflows, a pattern management views as routine over their 50-year history.
• Competitors experienced asset outflows later in Q3/early Q4, suggesting a market normalization, while Federated Hermes assets are recovering.
• The firm maintains a disciplined liquidity-first approach in money markets, refusing to extend maturities beyond their comfort zone to chase incremental yield, which contrasts with some aggressive competitors.
• Institutional separate account (SMA) sales remain strong, driven by consistent long-term performance of MDT strategies across various market caps and sectors.

Risks and Challenges:

• Redemption pressure in the Total Return Bond strategy due to client risk tolerance shifts, resulting in $1.7 billion in Q4 redemptions.
• Potential dilution of the blended fee rate as new institutional sub-advisory mandates (expected >$6.5 billion) typically carry lower fee rates than 401(a) mutual funds.
• Money market asset volatility linked to interest rate changes (Fed hike in September) and seasonal tax collection cycles affecting state pools.
• Revenue share data is not publicly tracked, creating a blind spot regarding relative performance against competitors on a fee basis.

Management Commentary and Tone:

• Tone is confident and disciplined, emphasizing "standard blocking and tackling" and long-term performance consistency as drivers of success rather than short-term tactical shifts.
• Management expressed satisfaction with maintaining operating margins above 30% and reiterated the long-term goal of reaching industry-leading fee structures.
• On digital assets, leadership adopted a cautious "steady as we go" approach, prioritizing infrastructure readiness over immediate acceleration of non-money market tokenization.
• Leadership emphasized that "taxes shouldn't drive the truck," advocating for underlying portfolio performance over tax-aware structures, though acknowledging active work on tax-aware products.

Analyst Questions and Answers:

• Flows vs. Competitors: Clarified that Q3 money market outflows were a normal market fluctuation due to liquidity choices and rate lags, with assets rebounding by $3.7 billion in October.
• Expense Sustainability: Confirmed Q3 expense control was sustainable barring higher compensation in Q4; no specific guidance provided for 2027.
• SMA Success: Attributed growth to strong long-term track records and a large distribution force, noting the diversification of wins across MDT strategies (all-cap core, large-cap value, etc.).
• Digital Strategy: Reiterated that the Prometheum deal is about building infrastructure for future demand, not immediate acceleration of sales.
• Fee Rates: Noted a bifurcation where retail channels (via intermediaries) may have higher fee rates than institutional products, though specific revenue share data is unavailable.
• Tax-Aware Products: Confirmed active discussions on tax-aware long-short products but maintain that performance must precede tax considerations.

Other Key Points:

• Federated Hermes reported a total of ~$890 billion in managed assets across all categories as of early November, with money markets comprising ~$654 billion and equities ~$112 billion.
• The Total Return Bond Fund maintained top-tier performance rankings (top third 10-year, top 28% 1-year) prior to the specific redemption event.
• The firm continues to see strong demand for short-duration fixed income products (ultra-shorts, micro-shorts) as interest rate expectations evolve.
• Intangible asset amortization expenses decreased significantly as the majority of assets from the Hermes acquisition were fully amortized.