Good morning, everybody, and welcome to Federated Hermes, Inc. Q2 2023 Analyst Call and Webcast. Please note, this conference is being recorded. I will now turn the conference over to your host, Raymond Hanley, President of Federated Investors Management Company. Raymond, over to you.

Good morning, and welcome. Thanks for joining us today. 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 Federated Hermes Limited; and 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 Hermes' actual results may be materially different than the results implied by such statements. Please review the 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, and Tom will comment on our financial results. Looking first at equities. Assets were down $637 million to $83 billion due largely to net redemptions of $828 million, partially offset by market gains of about $115 million. Even so, we saw Q2 positive net sales in 15 equity strategies, including Asia ex-Japan, MDT's large-cap growth, MDT Mid-Cap Growth, and international leaders. Now the strategic value dividend domestic strategy had Q2 net redemptions of $700 million compared to net sales of $727 million in the first quarter. As we have talked about before, this strategy is outcome-driven and is benchmark-agnostic. It seeks a high and rising stream of dividend income from high-quality companies. Over the last 10 years ended June 30, it has returned on average 7.4%. To make the point, the strategy returned 8.5% in 2022 compared to a loss of over 18% from the S&P 500 and thereby ranked in the top 1% of its Morningstar assigned category of large cap value for this 2022 performance. Year-to-date, however, through June of '23, it has a negative return of 5.3% compared to the S&P 16.9% gain, and that ranked it in the 99th percentile of its assigned category. This year, the market, as you know, has been led by a small group of technology companies that are largely outside of this strategy's objectives, as they either pay no dividends or have a low dividend yield. The top yielding quintile of stocks in the S&P 500 are underperforming the bottom yielding quintile by nearly 40% to-date. Now this strategy would benefit as investors rotate back into cheaper high-yielding defensive stocks. Looking at our equity performance overall compared to peers and using Morningstar data for the trailing three years. At the end of the second quarter, 50% of our equity funds were beating peers and 29% were in the top quartile of their category. For the first three weeks of Q3, combined equity funds and SMAs had net redemptions of $310 million. Now turning to fixed income. Assets decreased slightly in the second quarter to $87.4 billion. Fixed income funds and SMAs had Q2 net sales of $454 million, while fixed income institutional separate account net redemptions of $526 million were driven by regular cash flows from a large public entity. Within funds, our flagship Core Plus strategy, Total Return Bond Fund had Q2 net sales of about $1 billion. Core Plus and other fixed income SMA strategies added $207 million of Q2 net sales, while net redemptions of about $354 million occurred in the three Ultrashort funds. The Ultrashort net redemptions were down from $1.2 billion in the prior quarter. Just as a note, total AUM and Ultrashort are about $5.4 billion here at mid-July. We had 15 fixed income funds with positive net sales in the second quarter, including, of course, total return bond fund and SDG Engagement High Yield Fund. Regarding performance. At the end of the second quarter and using Morningstar data for trailing three years, 49% of our fixed income funds were beating peers and 16% were in the top quartile of their category. For the first three weeks of Q3, fixed income funds and SMAs had net positive sales of $20 million. In the alternative private markets category, assets increased by $428 million in Q2 compared to the prior quarter, reaching $21.6 billion. The increase was due to FX impact, partially offset by net redemptions and distributions. We had the final close of PEC 5, the fifth vintage of our private equity co-invest fund in June, reaching $486 million in commitments, which exceeded our $400 million target. Commitments came from existing PEC Series investors as well as new investors from Europe and South Korea. Federated Hermes GPE has a 22-year track record of making co-investments, having committed $4.5 billion across 278 global co-investments as of March of '23. We continue to market Horizon 3, the third vintage of our Horizon series of private equity funds. Horizon 3 has commitments of a little over $1 billion through the second quarter. We are also in the market with the Hermes Innovation Fund, which is the second vintage of our Private Equity Innovation Fund, the first vintage of our real estate debt fund and the first vintage of our nature-based solutions fund. Now we began the third quarter with about $5 billion in net institutional mandates yet to fund, both in the funds and separate accounts. These wins are diversified across fixed income, equity, and private markets. Fixed income expected net additions totaled $2.5 billion. This includes wins in active cash, short credit, corporates, high yield and core plus. Approximately $1.3 billion of total net wins is expected to come into private market strategies. This includes private equity, direct lending and absolute return credit. About $1.2 billion of total net wins is expected to come into equity strategies, including biodiversity, global emerging markets, MDT Mid-Cap Growth, and Global Equity. Moving to Money Markets. We reached record highs for money market fund assets of $364 billion and total money market assets of $509 billion. The second quarter presented a challenging environment for managing money market strategies as the debt ceiling crisis significantly impacted short-term debt markets. Despite this challenge, money market strategies continue to benefit from favorable market conditions for cash as an asset class, higher yields, elevated liquidity levels in the financial system and favorable yields compared to bank deposits. As short-term interest rates peak, we expect market conditions for money market strategies will be favorable compared to both direct markets and bank deposit rates. Looking at flows in money funds in the second quarter, we saw good activity from products geared to the retail customers of financial intermediaries. Institutional product flows were challenged by the debt crisis and direct security yields during the regular June corporate tax period. Now the SEC, as you know, recently adopted new rules for money market funds. We continue to study these rules to assess their impact. We were pleased to see that swing pricing was not included and that the ability to use a reverse distribution mechanism was included as an option and a remote possibility that negative yields were to occur. We were also pleased that the SEC agreed with our recommendation to remove temporary redemption gates and the link between weekly liquidity asset thresholds and liquidity fees, which we believe created an incentive for investors to redeem sooner in periods of market stress and prevented management from using as much liquidity as was available. The inclusion of mandatory redemption fees subject to certain conditions in institutional prime and muni funds presents a challenge for fund advisers and investors. We have approximately $11 billion in third-party institutional assets in institutional prime and muni funds that we believe could shift to alternative products that we offer, including our private prime fund and government money market funds. It's worth noting that institutional prime and muni funds already have fluctuating net asset values and that there is an exception or a carve-out for so-called de minimis impact based on the hypothetical selling of a strip of securities that may occur on the rare days when we have a 5% redemption trigger. We will be talking with our institutional clients over the coming months on this topic. We believe that these investors will continue to use the institutional prime and muni funds, at least into late next year when the new rules take effect. Our estimate of money market mutual fund market share, including sub-advised funds, was 7.2% at the end of the second quarter, down from 7.4% at the end of the first quarter. Now looking at recent asset totals as of a few days ago, managed assets were approximately $707 billion, including $510 billion in money markets, $84 billion in equities, $89 billion in fixed income, $22 billion in alternative private markets and $3 billion in multi-asset. Money market mutual fund assets were $365 billion.

Thank you, Chris. As described in the press release, Q2 results included two transactions that impacted results for a combined loss net of tax of $800,000. The transactions included a sale by a shareholder in one of our private equity funds of a portion of their investment to a third party and a restructuring of one of our infrastructure funds. We continue to manage both funds. Total revenue for Q2 increased by $51 million from the prior quarter, due mainly to an increase of $38 million in carried interest and performance fees, of which $25.9 million is from carried interest revenue from consolidated carried interest vehicles that was offset mainly by compensation expense. Retained carried interest and performance fees increased by $12.1 million from the prior quarter. Total Q2 performance fees and carried interest were $39.4 million. All other revenue increased by $13.1 million or 3% due mainly to higher average money market assets, bringing in $11.6 million of revenue and an additional day in the quarter, bringing in $4.6 million of revenue, partially offset by lower average equity assets, reducing revenue by $2.5 million. Q2 operating expenses increased by $37.8 million from the prior quarter, due mainly to $25.7 million of compensation expense from the consolidated carried interest vehicles and from $9.8 million due to the restructuring of the infrastructure fund recorded in other expense. All other expenses increased by $2 million or 1%. The $23 million increase in compensation and related expenses from Q1 included the $25.7 million in consolidated carry interest vehicle compensation and $1.4 million in severance, partially offset by $4.1 million of lower incentive compensation expense. The increase in professional service fees from Q1 was due mainly to higher legal and consulting fees. The increase in advertising and promotional expenses from the prior quarter is mainly due to the timing of certain conference and advertising spending. The effective tax rate was 27.4% for the quarter. The Q2 rate was impacted by the restructuring of the infrastructure fund, which included the purchase rights to receive future carried interest; this purchase and related expenses were not deductible for tax purposes. As a result, our effective tax rate was higher this quarter compared to our expected rate of 24% to 26% for 2023. At the end of Q2, cash and investments were $521 million, of which about $459 million was available to us. Jenny, we would like to now open up the call for questions, please?

Thank you. Your first question is coming from Daniel Fannon of Jefferies. Daniel, your line is live.

Thanks. Good morning. So I wanted to start with just money market flows and understand your comments that as rates stabilize or peak, you expect to see those flows pick up. But also just want to contrast that to what we're hearing just broadly about fixed income flows also picking up when that occurs. So how do you think investors and the balance between what bond funds and money market funds are going to look like as we get towards more of that peak rate or lower rates potentially dynamic?

Daniel, I'll comment on the bond fund portion, and I'll let Debbie add on the money market portion. So our franchise, the Core Plus franchise, total return bond has over $18 billion in it and it is a great bucket to have a very good story over the long term. As we're looking at the fixed income market, that is a big allocation, almost no matter what is going on in the marketplace. Therefore, we are winning mandates where that is a core position and how people are feeling is a little different than a core allocation. We are winning in that space. If you talk to the financial advisors, they are somewhat reticent to go into the market full bore, even though you've seen some changes along those lines with market performance. They are quite sanguine about a core position in the Core Plus fund that has this kind of record. I will let Debbie comment on the money market portion, and then I'll draw them back together after her comments.

Thanks, Chris. So from the money market side of the equation, much of the growth that we have seen so far has come from the retail side of the market. This is simply because compared to bank deposit rates, where they were for much of the zero rate environment, money market funds are now paying a much more attractive market rate of return. For institutional buyers, however, they generally have the ability to be in direct markets, specifically by buying direct commercial paper or CDs. As the market has increased, they have been purchasing direct market securities such as those in order to pick up the higher yield more quickly. Money market funds operate with a lag, maybe 25 to 30 days depending upon our weighted average maturities. Once markets peak or plateau in this case, and even more so when they start to go down the other side, the opposite occurs for institutional investors where they come into those funds that actually lag the market and therefore stay at that higher rate for a longer period. It is generally at that point that we would see institutional markets and the institutional flows pick up while retail will be maintained. This comes from two different sources. The retail side, as money is coming off a zero, becomes very attractive versus bank deposits. And then once rates plateau and start to go down even marginally, it comes from the institutional side. So that is the situation; these are generally cash management flows. It doesn't include what Chris was talking about, those flows that would ultimately make their way back to the longer side of the fixed income markets or even the equity markets for that matter.

Okay. Thanks. So what's really going on here is it's almost independent decisions in addition to filling out a core position. Those financial advisors that are willing to lengthen duration like the product. The product does a very good job of capturing alpha on the downside and on the upside. If you look at its three-year rolling returns over 72 periods, about 90% of the time, this fund beats the competitors and the benchmark. It's a very solid product. Others are consolidating managers and doing other things like that, which is why you're seeing these strong flows into the total return bond fund category.

Okay. Thank you. That's helpful. I hoped to clarify some of the dynamics within the carried interest in the quarter. I think you mentioned the restructuring of the infrastructure fund. So if you could just talk about specifically what happened and then understand the impact to carried interest and comp. But I believe that was partly why the elevated legal costs as well? I just want to make sure we're looking at the kind of normalized expense levels exiting the second quarter; that would be helpful.

Yes. Okay, Dan. That's why we put that kind of specific things in the press release under financial summary, but just to talk about it. We have the Horizon product, which has a long-term large private equity investor looking to exit some of their position. We worked on this for a long time, and they were able to complete the transaction, selling their position to somebody else; importantly, we still are managing it. This triggered the carry from the gains that were obtained by selling it, which triggered the carry of which we get some of it, and the managers get some of it as well, which is why it is compensation. So that standalone would have been a positive contribution to earnings. The second transaction was in our infrastructure business, where we looked at it and realized that we needed to update it to better satisfy existing investors and to restructure it to grow in the future. That triggered carried interest from the past that we were able to recognize. We were able to recognize it because there was a clawback, and once we restructured it, the clawback ended, allowing us to recognize it. We also had to obtain a fair market value of the cherry for the people who get the carried interest, which we had to take as an expense. That was not a comp expense even though it's paid to the employees and showed up in the other line. Now both those transactions continued to manage that portfolio too. I think it's important for Saker if he wants to make any follow-up comments on those businesses.

Sure. Thank you. Two things about this. First, if you consider the first transaction, it is actually a success because when you have a private market investor, they tactically value the long-term and should ensure that they are there for the long term. You also want to ensure that if they need liquidity at some stage, we can help them find someone else, which is what we did. That then triggers a realization of some of our carry for both us and for the managers. The second one is different in the sense that the clients themselves wanted us to restructure the fund so that it aligns with what they want to do. Again, we kept management of it. The first key point is that we have control of the management of both. The second point is, this gives an indication of how private markets work, which is much revenue is generated within private markets through these lumpy carry payments that happen over time, which we do not predict, but you can look at our past strategies to see averages over time. We have established a strong reputation in all parts of private markets and private equities. Our track record is outstanding. This combination keeps clients, expands our client bases, and allows us to realize some of the carry, some of which goes to the managers and some comes to us as the house. This gives you insight into how private markets work and how attractive this business is because of its stickiness, longevity, and the carrier's interest generated within it for us as well as for our clients.

So Dan, the last comment that I have is we put in the net-net-net on all these things, which I understand are complicated to figure out. That's why we indicated that the after-tax impact was only $800,000 when you take all these transactions and millions of dollars. We wanted to give you an indication that it wouldn't have impacted earnings too much, about $800,000 exactly.

Okay. Thank you.

Thank you. Your next question is coming from Patrick Davitt of Autonomous Research. Patrick, your line is live.

Hi. Good morning, everyone. The press reported on some money fund fee cuts earlier in the month, but I think misrepresented the impact. So could you frame any immediate impact to the earnings model from those reported changes? More broadly, what exactly are the changes you made? And any color on the reasoning for the new framework? Thank you.

Yes, Patrick, it's Ray. We did in the beginning of May, the fund board approved a reduction in investment advisory fees on a group of our money funds. As you indicated, there's no impact to our revenue because we already had long-standing advisory fee waivers, so this was not revenue that we were collecting. It may have been reported as such. In addition, in the beginning of July, we launched 10 new share classes on three of our treasury funds. We did that to give clients additional product options and to have some consistency when looking at our treasury products compared to the government and prime funds regarding expenses and minimum investments and other features. The creation of these new share classes, priced at 15 basis points net of waivers, represents a lower net effective fee rate than what was previously available. This is in line with moving towards where some of the competitive funds are and providing that consistency. We already had that pricing option on the government side, which is the bigger category. Those are the changes at a high level. Debbie, I don't know if you want to add anything to that?

Yes. I think just that we really don't expect it to be impactful in the assets in those products, and any kind of shift that might take place between share classes within a product we expect to be modest at this point.

The intention, of course, is to regardless of shifting and if any of that occurs or when we undertake changes like this, our expectation is that they will be revenue enhancing.

Got it. Thanks. As my follow-up, you're building a fairly nice cash balance and did a lot more repurchases in the second quarter than I think maybe your tone on the last call would have suggested. Should we be leaning more into repurchases as we think about our models for the second half now that your price is much lower than it was last quarter?

Yes, Patrick, it's Tom. We had the Russell index change, and we weren't sure what was going to happen there and wanted to be prepared. We also knew that the money market regulation was coming, and we weren't exactly sure what would happen there. Looking into the future, the Russell is behind us. We did buy shares during that period because we thought there was a lower price than appropriate for a buying opportunity. Now that the money market situation is not as problematic as it could have been, we believe that our stock is underpriced, and we will review our strategy to buy shares based on that thought process.

Thank you very much. Your next question is coming from Mike Brown of KBW. Mike, your line is live.

Great. Good morning, everyone. You just touched on the dynamic with the Russell removal there. We received a number of inquiries about that dynamic and the resulting technical pressure on the stock. Can you touch on this dynamic a little bit more? Given your governance plays a part in your investment strategy, why not meet the requirements to stay in the index?

So I'll deal with the first part, and Chris can answer the last question. The dynamics are hard to understand. We looked at our volume and saw that before the index date, our volume picked up and the price came down. If you look at a month or so before the change, the price went down consistently while the volume went up. Whether that was due to people adjusting portfolios in advance of the Russell change or those betting against the outcome is hard to say. After a big volume day, I forget 12 million shares or something on the day the Russell changed, the few days before, the stock outperformed the market, and then roughly five days after, it underperformed.

Changing in order to meet an index didn’t strike us as the way to do the strategy for Federated Hermes, Inc. The decision of index makers doesn’t mean that we have to decide to align with their non-index index. We've maintained this structure since going public in the 1960s. It’s crucial to clearly define who is in charge and managing the money. Our focus remains on investment management performance and enterprise growth. Because we generate cash flow, we can leverage these incongruities as buying opportunities for our underlying stock. We are satisfied with our structure and position.

Okay. Thank you for those thoughts. As a follow-up, if I approach the capital allocation question differently, are you seeing opportunities on the M&A front? How are you thinking about some strategic opportunities that would best fit Federated Hermes and could take you to your next evolution of growth?

Okay. It's Tom. We've spoken before about looking into the real estate development area. That’s likely going to be a long process. It's likely an acquisition in the U.S. We'll need to establish skills and expertise that we have in London and bring them to the U.S. That will require time and effort. I would expect that it will take a while to find something that aligns with us. We don’t have needs in growth or quant or value. Those would likely involve more roll-up activities. We're fully committed to the money fund business, and if someone wants to exit, we are a highly interested player.

Thank you very much. Your next question is coming from Brian Bedell from Deutsche Bank. Brian, your line is live.

Great. Thanks. Good morning, folks. Thanks for taking my questions. First on the money market side, sort of a combo question on the proposals from the SEC, particularly the liquidity rules going from 10% to 30% in - I think overnight and weekly to 25% and 50% debt proposal. Which subset of funds would that impact? How do you see the competitive yield dynamics on the retail side of the business?

Debbie?

Sure, I can take that. Going from 10% in overnight and 30% in weekly liquid assets that are required in the current rules to 25% in dailies and 50%, which will be required under the new rules, the only funds that will impact are the prime funds. Municipal funds are exempt from any kind of daily liquid asset requirements and only operate under weekly liquid assets. Most of our municipal and government products meet or exceed those 25% or 50% requirements for dailies and weeklies. It is really the prime funds that are impacted. We have always tended to manage our funds at something closer to 20 and 40, which is probably why we’ve managed a lot of outflows. The transition to 25 and 50 will have a basis point impact in those particular products, both retail and institutional. They can still maintain their competitive spread over the government sector, where they are primarily compared.

That's great color. And my follow-up will be on the strategic value fund. As you described this, it's typical classic performance versus the peer group, and now we are in this mega cap tech rally. Maybe just some color on your sales force and the advisers that you're selling this product to. Is it resonating that this is probably a good buying opportunity from at least a mean reversion perspective, or do you really find that advisers typically chase performance on this and buy it more when it’s outperforming?

You need to look at that in terms of when the money came in, how long it has been there and how the advisers presented the product. Last year, when it was number one, this is the exact experience we had before, the money that comes in because it's the number one fund, it's the money that goes out when that performance changes. However, the money that went in because it was a growth dividend story stays in. What financial advisers prefer over the long haul is for us to stick with our knitting and stay on course. The portfolio management team has solid experiences and has written extensively about these subjects, with a new book in the works. In terms of the efficacy of this type of investing, recent performance notwithstanding. However, the core group of fund holders remains steady and strong. That’s why I mentioned the 7.4% return overall over the last 10 years. That’s the key metric.

I would just add, we continue to have the strategy added to platforms, providing growth opportunities within platforms because it is an alternative to the small group of growth-oriented stocks driving returns. We've also launched ETFs late last year, which is around $60 million in assets; it's generating the same kind of experience. That is being added as an option for advisers.

Another comment would be, keep in mind we wrote nearly $500 million worth of gross sales in that fund during the quarter when we had net redemptions. The product is alive and well. Our commitment to this strategy is demonstrated by what Ray just mentioned, namely the new ETF, which reflects a long-term viable product.

Good morning. Thank you. Continuing the theme of money market roll-ups, can you frame for us with the higher rates and potential plateau and more certainty around regulation. How do smaller players look at that environment? Does it increase the confidence of joining with someone larger, or is it more episodic?

It depends on how the money got there and who controls the money at the moment of redemption. There are 50 to 60 listed money market fund players. The top 25 hold all the assets, and only the top 20 really compete for significant assets. It all depends on how that fits into your regular business. We have a sales force that calls upon all the players in the money market fund business to be a warm and loving home should they decide to change their minds about continuing their operations. It is often episodic; there is usually no avalanche after the last go-round of SEC regulation, and I don’t expect one after this either. Periodically, CFOs, CEOs, and money managers decide to change their approach, and that’s what we are looking for. I don't believe this will be a catalyst for an avalanche.

Got you. Outside of the strategic value dividend, can you discuss other equity strategies that you believe can see an uptick in demand to absorb some of those redemptions from SPD?

Well, the two MDT offerings have been performing excellently. The large cap and mid-cap growth funds are both picking up both regular fund business and large institutional business, with their growth being excellent. If you look at the International Leaders Fund, that’s another that has performed excellently over time and has a strong offering inside retail distribution. Additionally, Asia ex-Japan is performing outstanding in terms of flows and performance. The GEMS product, the emerging markets fund, continues to win institutional mandates. I may be skipping some of my favorites, but those are the ones that immediately come to mind.

Hi. Good morning, and thanks for taking the questions. Chris, SEC filings suggest you sold a substantial portion of stock during 2Q. Some digging suggests that some of this was done by a trust, and others were transfers to other vehicles controlled by your family. The end result seems like your direct interest in Federated is substantially lower than it has been in the past. Can you explain what appears to be selling during the quarter? How much stock do you directly own at this point? Is that enough to align your interests with shareholders?

There was no selling of stock, only transfers into a trust controlled within our family, which includes eight kids, six spouses, and 40 grandchildren. My commitment to this enterprise goes way beyond stock interest. Although I don’t know the exact number of shares I own right now, the bulk of shares are still owned by the family. It's a significant stake that reinforces our family's incentives. I should clarify that my mother, who passed away on December 12 of last year, did sell her shares, of which I am the trustee. These actions relate to distributions due to estate planning, various entities, charities, and children. Additionally, my mother’s 179th great-grandchild was born two days ago.

Congratulations on that. Thank you for your answer. As a follow-up, the share in money market funds you highlighted fell from 7.4% to 7.2% in 2Q. The dynamics for retail and institutional highlighted by Debbie in 2Q were true for your peers as well as for you during the quarter. What drove the loss of share in 2Q? Would you expect that loss of share to rebound in the second half of the year?

Sure. I think what drives it is that other money fund providers, which have a larger retail presence than we do, benefit from the environment when retail is growing more than institutional. We expect that to balance out as rates increase only in a minor way going forward; once they plateau and begin to decrease again, we expect that will influence the institutional flows significantly, where we play a larger role in the market.

That appears to be all the questions we have in the queue today. I'm going to hand back over to management for any closing remarks.

Thanks very much, and that concludes our call. Thank you for joining us today.

Thank you, everybody. That does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day and a wonderful weekend. Thank you for your participation.