Greetings and welcome to the Federated Hermes' Third Quarter 2020 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. Please note this conference is being recorded. I'll now turn the conference over to your host Raymond Hanley, President of Federated Investors Management Company. Thank you. You may begin.

Good morning and welcome. Leading today's call will be Chris Donahue, CEO and President of Federated Hermes; and Tom Donahue, Chief Financial Officer. Joining us for the Q&A are Saker Nusseibeh, CEO of the International Business of Federated Hermes, and Debbie Cunningham, our Chief Investment Officer for Money Market. During 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 the risk disclosure in our SEC filings. No assurance can be given for future results and Federated Hermes assumes no duty to update any of these forward-looking statements. Chris?

Thank you, Ray. Good morning all and thank you for listening. I will review Federated Hermes' business performance, and Tom will comment on our financial results. We continue to grow and expand our ESG engagement activities. During Q3, our staff level of engagers and other specialists reached 65, up from 60 at the end of Q2, and our assets under advice reached $1.2 trillion, up from $1.1 trillion in the second quarter. Now looking at our equities business, assets closed the quarter at $80 billion, up from $77 billion at the end of Q2, as market values continued to recover, adding $4.3 billion, offset partially by net redemptions of $1.4 billion. While overall net sales of combined equity funds and separate accounts were negative, we saw positive net sales in a number of strategies. We had 16 equity funds with net sales in the third quarter led by Kauffman small cap and the SDG engagement equity user it fund. Other funds include global equity ESG impact opportunities, international small mid-cap company, and global small-cap equity. Using Morningstar data for the trailing three years, at the end of the third quarter 24% of our equity funds were in the top quartile and 20% were above median. Looking at the strategic value dividend strategy, its objective is to provide a high and growing dividend income stream from high-quality companies. The domestic fund's 12 months distribution yield was 4.4%, which ranked in the second percentile of its Morningstar assigned categories at the end of the third quarter. The domestic strategic value dividend strategy had combined mutual fund and SMA outflows of $1.4 billion in the third quarter, down from $1.6 billion in the second quarter. While recent market characteristics have not favored our low-volatility high-dividend strategy, we believe that our continued focus on the core goal of providing a higher-than-market dividend yield from high-quality business assets will resonate with investors over the long term, especially in a low-rate environment. Q4 results through October 23 show combined fund and SMA net redemptions at about $190 million. Now turning to fixed income; assets reached another record high of nearly $80 billion at the end of Q3, up over $6 billion or 9% from Q2. The third quarter growth was driven by strong net sales of about $5 billion. Our broad arrays of solid fixed income strategies were well positioned to meet market demand. We had 23 fixed income funds with net sales in the third quarter. The multi-sector total return bond and short intermediate total return bond funds combined for about $1.2 billion of Q3 net fund sales. Ultra-short strategies had about $1.1 billion of net fund sales, and high yield added just over $400 million of net fund sales. Corporates, high yield, multi-sector, government, and municipal bond funds all had net sales, as did our fixed income SMA. Across sectors, short duration strategies were in demand and also drove the fixed income separate accounts net sales. At quarter-end using Morningstar data for the trailing three years, we had 26% of our fixed income funds in the top quartile and 50% were above median. We began Q4 with about $1.5 billion in net institutional mandates yet to fund mostly in fixed income. Moving to money markets; the Q3 asset decrease of $25 billion was mostly from money market funds, which decreased from Q2's record high, and to a lesser extent, seasonal declines in separate account assets. Money market fund asset decreases were attributed to corporate clients using cash to pay down debt or spend on their businesses and to some degree, the use of cash by government entities among other factors. Our money market mutual fund market share, including sub-advised funds at quarter-end was nearly unchanged from the prior quarter at 8.1%. Taking a look now at recent asset totals; managed assets were approximately $614 billion, including $430 billion in money markets, $81 billion in equities, $81 billion in fixed income, $18 billion in alternatives, and $4 billion in multi-asset. Money market mutual fund assets were $322 billion. Overall, we continue to function well through the challenges of COVID. Upwards of 95% of our employees are successfully working from home, leveraging progress from years of technology investments and strong culture. We recently communicated that we are delaying a significant return to our office for US employees until mid-February. Our decisions about when to return more employees to our offices will be informed by conditions and not the calendar. We have emphasized that working together in our office is vital to Federated Hermes' culture. It facilitates collaboration, allows impromptu conversations, and promotes personal interactions that build camaraderie and creativity. Culture means community, collaboration, and cooperation, and it's best accomplished in the office in my opinion. We would lean on wanting people to come back to the office when it's proper to do so.

Thank you, Chris. Total revenue for the quarter was up about $4 million from the prior quarter, due mainly to higher equity and fixed income assets, which combined to add about $20 million of revenue. This was partially offset by net money market minimum yield and other waivers and lower money market assets, which combined to reduce revenue by about $18 million. Recall that in Q2, we saw revenue growth from higher money market assets partially offset by lower revenue from equity assets. Our diversified business mix positioned us to grow revenues in varying market conditions against the backdrop of challenging times. Other factors impacting Q3 revenues compared to the prior quarter included an additional day, which added $4.4 million and a decrease of $2.9 million in performance fees and carried interest. Looking at operating expenses, comp related increased $2.6 million from the prior quarter due mainly to higher headcount and FX rates, and higher benefits and other costs. The decrease in distribution expense compared to the prior quarter was due to the impact of minimum yield waivers and lower money market assets, which reduced distribution expense by about $18 million. This was partially offset by an additional day in the quarter and higher equity and fixed income assets. Other expenses include a $1.1 million revaluation from the contingent purchase price liability from the first quarter MEPC acquisition. Also impacting the other expense line item was a decrease of $1.8 million of expenses from derivatives. This is from Hermes hedging their dollars into pounds. The impact of money fund yield related waivers on operating income in Q3 was $3.8 million. Based on recent assets and expected yield, the impact of these waivers on operating income in Q4 could be about $9 million. And we think that's about where it will level off. Multiple factors impact waiver levels, including a potential additional stimulus package, which is included in our forecast. Non-operating income decreased from the prior quarter due mainly to the lower increase in the value of seed and other investments in the third quarter. As noted in the press release, the Board approved a $1.27 per share dividend, including a $1 special dividend. We've declared five special dividends for a total of $7.53 per share, or about $0.75 billion in the last 12 years. We will pay the dividend from cash on hand and it will be considered an ordinary dividend for tax purposes. The Q4 dividend payment is expected to reduce Q4 earnings per share by about $0.015 per share, due largely to the exclusion of the dividends paid on unvested restricted shares from net income under the two-class method of computing earnings per share. During Q3, we purchased 867,000 shares for $20 million, with nearly all of this purchased in the open market. At the end of the third quarter, cash and investments were $437 million, of which about $370 million was available to us. Debt at the end of the quarter was $90 million. We would like to open the call up for questions now.

Our first question is from Ken Worthington with JPMorgan.

Hi, good morning. Regulators and regulatory panels continue to discuss the idea of altering money market fund regulations, particularly in response to the need for Fed programs to support funds post-COVID. What are the fixes that are being most talked about? And could this round of rules either damage the outlook for prime money market funds? Or is it more likely that it actually helps the outlook for prime money market funds?

Thanks, Ken. This is Chris. I believe that the thing that's being discussed the most is the restriction on that 30% trigger. The comments that were made to the SEC regarding not only the requirement for a 30% weekly liquidity level, but then requiring public notice of that and the consideration by the board of fees and gates acted exactly the way that was predicted. Namely, it caused more problems than it solved. There are many ways around that if the SEC wants to keep the trigger; fine, they just don't have to do the things that wave a red flag in front of the marketplace. Ameliorating the impact of that 30% seems to be the number one issue being discussed. At this point, in our view, the money market funds came through this situation much like they did before, with a lot of resilience; therefore, there is no need to further diminish prime funds, even though there are some who use them as trading mechanisms to preserve their non-SIFI status. The reason for this is if you take an honest look at stakeholders: stakeholders include issuers, which include colleges and municipalities, all of whom need great help during COVID and post-COVID times. Restricting their ability to get financing on the short end doesn't make much sense. Additionally, stakeholders include users, which again include that same group, and then you have other shareholders. We just don't think that it makes a lot of sense to eliminate the spear point of the short-term markets at this time. So what will happen with regulation, I cannot predict; but I assure you that we will be in there defending the beauty and efficacy of prime money market funds.

Great, thank you. You had pretty substantial outflows in money market funds this quarter, and pretty strong net sales into fixed income funds this quarter. To what extent is the money that's coming out of cash going into fixed income? And really the heart of the question is, to what extent can you cross-sell or cross-market cash management clients and intermediaries to retain those dollars coming out of money market funds, and point them toward federated fixed income business?

A truly lovely concept that doesn't work, and I can't defend. If I could, I would. We have discovered over many decades in the money fund business that money fund and cash determinations by clients are made based solely on cash. However, what happens is because you're there with the cash account, you can talk to them about the other beautiful options that you have. But being able to exactly calculate and follow money moving from cash into fixed income, we just have never been able to do. We have separate sales organizations that coordinate very closely, and I think a large part of the sales we had in this quarter were related to the breadth and quality of the fixed income offerings that our clients were able to see. You can be sure that the salespeople on the fixed income and equity side use the money market fund as a door opener; it's just very difficult to trace the money.

Next question is from Dan Fannon with Jefferies.

Thanks. So I wanted to follow up on the fee waiver outlook; you highlighted the potential for stimulus in that assumption for the $9 million. Can you talk about the sensitivities if there isn't stimulus and other assumptions that are embedded in that?

Sure, Dan. Thanks. There's a whole lot of assumptions and raises asset mix, client actions, and then you just mentioned the stimulus, which we acknowledged. Tracking our forecasts, surprisingly we have been pretty accurate. Our team thinks that there's going to be a stimulus package, and the size and timing matter. As we run through many factors, we've come up with an estimate of $9 million. If the stimulus package doesn't happen, we would run the numbers and expect a couple million more in waivers.

Okay, and then the relationship between the gross and the net with the distribution expense. Is there a point at which it becomes more negative to the overall profitability? And where do you cap out on the distribution expense offset?

Hey, Dan. It's Ray. So embedded in that when you see the numbers roll up in total is a group of about 40 funds and multiples of that in share classes. They all have different ratios of distribution revenue and expense. The answer to your question is yes. At higher fund fee levels, they're higher because they have additional distribution revenue and related distribution expense built into the fund. As you know, when and if rates go lower, that mix changes, and you have funds that have lower distribution revenue and expense beginning to get impacted by waivers. You can see that if you look at the history of waivers and the resulting impact on those line items from '09 to '16. It's really a function of the mix of assets across a wide base of funds and share classes, which makes it hard to model and predict.

Our next question is from Patrick Davitt with Autonomous Research.

Hey, good morning, everyone. Could you update us on the progress of the ESG application of the long-term business? Through that lens, any specific anecdotes you can give us of that transformation helping the flow picture for specific strategies as they move from non-ESG to ESG, particularly on the equity side? Thanks.

Well, Patrick, this is Chris again. The movement through full integration is in full operation. The theme is to be able to legitimately and in-depth convince investment teams looking for mandates or RSD, that we are authentic. This is not a cosmetic operation. We have these charts that we look at to go through each group on three different levels, from the initial analysis to the customization and integration with testing in each stage, with bar graphs showing our progress. The liquidity group that Debbie runs is leading this effort and has integrated, in fact, is now engaging with some of the GSEs as part of that effort. The strategic value fund is also complete in this process, as are the high yield group and others, which are proceeding well. This remains a commitment. In response to your second question regarding sales, it's very hard to discern because when you integrate into the entire money market franchise, I don't think you can say, 'Oh, we got these ones or those from ESG.' I will allow Debbie to provide you with incidental observations on that. It's very, very difficult to track, as the same applies in the other areas I mentioned. Where you do see it is in some funds from our UK operation with positive flows around the globe.

Thanks, Chris. The reason we are the most fully integrated group within the three different sectors at Federated Hermes has to do with the fact that we, by rule 2a7, for our money market funds and mutual funds, are required to only deal with issuers that represent minimal credit risk, high quality, and minimal credit risk. For the most part, we're dealing with the largest companies, the largest financial entities globally. Although there may be governance issues or environmental issues from BPs and Exxons, there may be social issues from some pharmaceutical companies we use. The fact of the matter is, they're leaders in the industry, and we are engaging with them to move those issues forward. Regarding COVID, we've engaged with a large soft drink manufacturer about their use of plastics. At the onset of COVID, they repurposed their plastic manufacturing lines to produce PPE for healthcare workers. Similar stories exist with other retailers who repurposed employees instead of laying them off. We've begun conversations with our top five GSEs in the country about engaging on ESG issues, and they are excited about the opportunity to start working with Federated on this front.

Thank you, Debbie. Before we leave this question, I'd like to ask Saker Nusseibeh from the UK to comment on equities and how this integration works from his perspective.

Thank you, Chris. As you might recall from previous discussions, ESG is integrated into everything we do in London. We do see increased flows into ESG across Europe and increasingly in Asia. It allows us to launch specialist funds seen as being true to the market, going one step beyond. For example, the impact fund, which has raised strong asset flows, and the high-yield SDG fund that aims to strengthen SDG and others we have been launching. We observe connectivity between ESG integration, being seen as authentic, and fund flows into both mainstream funds that integrate ESG and specialist funds that go further. We have plans to introduce new offerings to the market in the near future.

Got it. And real quick as a follow-up to earlier, did you give the quarter-to-date bond flow number again in the pipeline? I missed that.

The pipeline number is about $1.5 billion, primarily in fixed income. The quarter-to-date number for assets is over $800 million positive.

Our next question is from Mike Carrier with Bank of America.

Hi. Good morning. Thanks for taking the questions. Tom, I realize there are many moving parts with the waivers or the operating margin from 27% to 21%. Integrated and long-term assets were up a healthy amount. Any other key drivers? How are you thinking about the outlook within that broad range? Not just for the quarter, but over the next couple of years?

The market goes up when we lose a revenue number and an expense number, both close to each other. At that point, it looks like we're smart expense managers. If revenue goes down, expenses will also go down, which we will be content with, as our earnings would be higher.

Got it, okay. And Chris, just wanted to get your thoughts on M&A. You have done strategic roll-ups several times, but there has been more activity in the sector. Do you feel like the firm has enough skills in the areas that you need?

Mike, we are always looking for roll-ups. As I like to say, we are a warm and loving home for those so inclined. We always have a few we're considering. It's not a question of size but rather where we can fit it in and improve operations. We are focused on collaboration with our associates in the UK to grow and integrate this franchise. When you look at what we did earlier this year—completing the acquisition of real estate, private equity, and infrastructure aspects of the Hermes business, and the investments we've made in ETFs—it provides insight on where we're headed. We don't have significant size in ETFs yet; however, we are working on building that out, aiming for 2021 to file and announce products.

Our next question is from William Katz with Citigroup.

Okay, thanks very much for taking the question. Just returning to flows; it looks like the alternative pocket has bounced back. Can you talk about where you see the best opportunity? Additionally, how should we think about performance fees rolling to the P&L over the next 12-24 months?

Saker, I’ll let you handle that.

Thank you, Chris. Regarding carry fees in London as part of Federated Hermes, we have two types; one is straightforward carry fees from our private equity business, and the other is performance fees from property. These fees tend to arise towards the end stage of development projects we've worked on for quite some time. Performance fees from property have been strong this year, and we expect them to remain consistent. The property business has generated solid fees, while growth in our private equity business will lead to increased ratios in the future. We cannot disclose specific numbers, but the strong performance fee related to property is expected to continue.

When you look for where you can grow incrementally, are there any flagship categories or buckets of opportunity you see over the next year?

The way the property business has grown is through finding key clients with whom we form long-term relationships. These investments tend to be large, often between $300 million and $700 million, with commitments of around 15 years. We are constantly in discussions with clients to explore investment opportunities. This is not a prediction but we expect significant opportunities to emerge with our existing clients.

Bill, you asked about flows, especially in London. In Q3, two strategies had a notable uptick in sales: the unconstrained credit fund and the absolute return credit fund.

Yes, absolutely. The uptick you see is not in private markets, where the focus on performance fees lies. We've seen growth for our fixed income funds, and the multi-asset credit fund has generated significant demand in the UK market. Our marketing efforts in fixed income have been strong and are likely to continue.

Okay, just a follow-up for Tom. You mentioned the work-from-home timeline to February. Can you talk about the trajectory of non-comp expenses, as they didn't appear particularly depressed this quarter, just looking at one-offs? How should we think about that moving toward normalization next year?

The TNE in the press release is still running at a low level. We discussed this with our salesforce during the budgeting process and their expectations for the second half of the year is full throttle. They think the first half will operate at about half the norm, which is contingent on the circumstances surrounding the virus and people's willingness to travel. We see ongoing investment in technology, but do not foresee outsized changes in office occupancy costs. Distribution expenses will fluctuate with waivers and market movements. Advertising and promotions will gradually re-emerge, especially related to the Federated Hermes name change as we adapt to COVID constraints.

Our next question is from Kenneth Lee with RBC Capital Markets.

Hi, thanks for taking my question. I'm curious about your expectations for near-term fund flows in the money market fund side, especially considering activity around corporate and government clients, along with seasonal influences that usually favor Q4. What are your thoughts?

Debbie, your turn.

Generally speaking, our liquidity products do see inflows at the end of the year, though this may be mitigated by lower interest rates and substantial inflows earlier in the year. Much of that cash has already been directed to our products, including stimulus funds now being utilized. Depending on election outcomes, short-term markets may react by seeking to lower rates temporarily. Demand may exceed supply until stimulus enters the marketplace. If there is any spread widening in the credit markets, outflows could occur. Overall, Q4 typically remains a strong quarter for positive flows.

Our next question is from John Dunn with Evercore ISI.

Thanks and hi. You're indicating a pipeline mostly in fixed income. Is the mix similar to what is inflowing now, and has the timing of funding changed at all? It would also be interesting to learn about the makeup of equity.

On the fixed income side; it is similar to what's happening now. We're seeing strong demand, especially in high yield. On the equity side, it includes a couple of Hermes institutional mandates, which we expect to come in. Overall, we always present a net number, anticipating that a couple hundred million will come in, and likewise, a couple hundred million will go out. That said, while we have known entries to track, it's important to stress that timing can vary. These are not necessarily Q4 inflows; some may fund into next year.

Got you. And a bit more on MEPC, how does the current environment we're inheriting impact that push and pull between investing but also benefiting from disruption?

Did you say MEPC?

Yes, well, Saker, would you like to discuss timing?

Timing on new clients is hard to predict. What I can tell you is that projects engaged with NETCO continue to develop and generate income. The United Kingdom is undergoing a significant transition, prompting developments in smaller cities. We're focusing on projects of significant scale in this area because technology makes it more feasible to move investments away from costly locations like London. Our current projects are multi-year in nature, requiring considerable time to attract clients for investment. However, once secured, these projects typically promise long-term engagements of around 15 years.

And our final question is from Robert Lee with KBW.

Good morning, everyone. Thanks for your patience and for taking questions. I have a couple; could you talk a little about your ETF strategy? You've referenced the plans to ramp up efforts in 2021, but given the activity seen with BlackRock and others benefiting from ESG demand, would it be reasonable to assume that this will be a focus for your initiatives?

That is included. However, the overall picture is that the active ETF market is still relatively nascent, comprising less than 3% of the total ETF business. Our activity aims to develop a few strategies next year—likely a couple in fixed income and a couple in equity. Behind the scenes, we are working on the necessary technology, strategy, and distribution to support this growth. Following that, we expect to introduce additional offerings. The majority of these offerings will likely be fully integrated with ESG, emphasizing the importance of our brand integration.

Great. One last question; I appreciate your patience. If we looked at flows this quarter or year-to-date, how should we perceive the contributions from Hermes and Federated? It's one team one dream, but what's the relative performance focus?

For this quarter, flows were weighted more toward the legacy Federated side, although Hermes also saw positive net sales. Historically, we've observed both sides contributing positively.

Rob, I’d add that the term 'Hermes contribution' refers to our UK operations. The importance of EOS data and methodologies cannot be overstated as part of Hermes' contribution to the ethos and branding of Federated.

We have reached the end of the question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Thank you, Sherry. That concludes our remarks for today. We thank you all, including our youngest participants, for joining us today.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Have a great day.