Greetings. Welcome to the Federated Hermes, Inc. Q3 2023 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 will now turn the conference over to your host, Ray Hanley, President of Federated Investors Management Company. You may begin.

Good morning, and welcome. Thank you for joining us today. Leading today's call will be Chris Donahue, Federated Hermes President and CEO; and Tom Donahue, Chief Financial Officer. And joining us for the Q&A are Saker Nusseibeh, who is the CEO of Federated Hermes Limited, our international operation; and Debbie Cunningham, the Chief Investment Officer for the money markets. During the 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, Tom will comment on the financial results. We had solid asset growth in Q3, ending with record assets under management of $715 billion, driven by record money market assets of $525 billion. Fixed income produced solid growth as well. Looking first at equities. Assets were down $5.7 billion to $77.3 billion, due to combined market losses and FX impact totaling $3.3 billion and net redemptions of $2.4 billion. We did see Q3 positive net sales in 14 equity strategies, including MDP large cap growth, international leaders, and U.S. SMID equity. The strategic dividend domestic strategy had Q3 net redemptions of $1.5 billion. This strategy is outcome-driven and is benchmark agnostic as we have said each quarter. It seeks a high and rising stream of dividend income from high-quality companies. As of 9/30, the fund had a weighted average dividend yield of 5.1%, compared to a 1.6% yield in the S&P and the fund has seen 39 dividend increases and zero cuts in the trailing 12 months. Looking at equity performance, compared to peers and using Morningstar data for the trailing three years end of Q3, 54% of our equity funds were beating peers and 33% were in the top quartile of their category. For the first three weeks of Q4, combined equity funds and SMAs on the equity side had net redemptions of $753 million. Now turning to fixed income. Assets increased by $2.3 billion in Q3 to $89.8 billion with fixed income separate accounts reaching a record high of $47.2 billion. Fixed income institutional separate account net sales of $3.8 billion were driven by the funding of a $2 billion in an institutional multi-sector mandate and by approximately $1.3 billion from a large public entity. Fixed income SMAs had Q3 record gross and net sales of $572 million and $320 million, respectively. Fixed income funds had net redemptions of about $684 million. Within funds, our flagship Core Plus strategy, total return bond fund had Q3 net sales of about $466 million. So that includes both the fund and the CIT. Core Plus funds and other fixed income SMA strategies added $320 million of Q3 sales. The three Ultrashort funds posted net redemptions of about $462 million. We had 15 fixed income funds with positive net sales in the third quarter, including the Total Return Bond Fund, the total return bond collective investment fund, the intermediate Corporate Bond Fund, and the Sterling Cash Plus. Regarding performance, at the end of Q3 and using Morningstar data for the trailing three years, 31% of our fixed income funds were beating peers; 17% were in the top quartile of their category. For the first three weeks of Q4, fixed income funds and SMAs had net redemptions of $77 million. In the alternative private markets category, assets decreased by about $1.3 billion in the third quarter from the prior quarter came to $20.3 billion. The decrease was due to FX impact of just under $800 million, market value decreases of about $300 million and net redemptions and distributions of about $200 million. We are in the market with Horizon 3, the third vintage of our Horizon series of global private equity funds. Horizon 3 has closed on commitments of $1.05 billion through the third quarter. We're also in the market with the Hermes Innovation Fund II, the second vintage of our pan-European growth private equity Innovation Fund. We had our first close in August for approximately EUR100 million, and we're in the market with our first vintage of our U.K. Nature Impact Fund. We began Q4 with about $4.9 billion in net institutional mandates yet to fund in both funds and separate accounts. These wins are diversified across fixed income, equity, and private markets. Fixed income expected additions totaled about $3.1 billion, which include wins in active cash, short credit, high yield, and corporates. Approximately $1.5 billion of total net wins is expected to come in private market strategies with wins in private equity, direct lending, and absolute return. About $227 million of the net total wins is expected to come into equity strategies and wins included mandates in bio equity, global equity, and gems. Moving to money markets. We reached record highs for the money market assets of $385 billion, and total money market assets of $525 billion. 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, of course, favorable yields, compared to bank deposits. At short-term interest rates peak, we expect market conditions for money market strategies will be favorable compared to both direct market rates and bank deposit rates. Looking at flows in money market funds in the third quarter, we saw good activity from products geared towards the retail customers of financial intermediaries. Institutional product flows continue to be challenged by direct security yields. Our estimate of money market mutual fund market share including sub-advised funds was about 7.3% at the end of the third quarter, up from about 7.2% at the end of the second quarter. Looking at recent asset totals as of a few days ago, managed assets were approximately $716 billion, including $527 billion in money markets; $74 billion in equities; $91 billion in fixed income; $20 billion in alternative private markets; and $3 billion in multi-asset. Money market mutual fund assets were at $385 billion.

Thanks, Chris. Total revenue for Q3 decreased $30.6 million from the prior quarter due mainly to the substantial carried interest and performance fees in Q2 related to the transactions we discussed on our last call. Q3 carried interest and performance fees were $14.9 million, compared to $39.4 million in the second quarter. All other revenue decreased by $6.1 million. Revenue from money market assets decreased by $9 million, offset by an $8.2 million decrease in related distribution expense. Changes in certain product structures drove these decreases, while higher average money market assets added to revenue. Q3 operating expenses decreased $33.6 million from the prior quarter due mainly to compensation related to carried interest and performance fees in Q2. We had lower money market fund distribution fees as discussed. Q3 included about $10 million in compensation related to carried interest. The decrease in other operating expenses includes a reduction of about $7 million in expense related to the infrastructure fund restructuring discussed in Q2 and partially offset by an increase of $3.7 million in FX-related costs and approximately $2 million of other expenses. At the end of Q3, cash and investments were $554 million, of which about $486 million was available to us. Holly, that completes our prepared remarks, and we would like to open the call up for questions now.

Certainly. At this time we will conduct a question-and-answer session. Your first question for today is coming from Dan Fannon at Jefferies.

Thanks, good morning.

Good morning.

I wanted to discuss your outlook for money market assets and in the context of rates. I think we've heard from others that fixed income is as rates peak is going to see a significant demand pick up, and I think you're talking about money markets as being also a beneficiary. So wondering what's the as we think about duration maybe being extended, how money markets you think will fare in terms of demand versus what would be more traditional fixed income asset classes?

I will start with some comments and then Debbie will add her thoughts. As we've mentioned in previous calls, once interest rates start to peak, we typically see an influx of institutional money, which is currently more drawn to direct securities. Therefore, we anticipate an increase in institutional flows. Currently, the retail side is in a strong position due to the rates, and coupled with financial advisers' hesitance to take positions and their uncertainty while earning over 5%, it's difficult to predict when they will choose to extend their investments. This forms the core of our outlook. It's important to remember that looking back at previous cycles from 2016 to 2018, following the initial decline, money market fund assets increased by 15%, while the industry saw a rise of about 11%. Our assets also grew over 20% through the third quarter of 2019 when easing began, and the industry experienced significant growth then as well. That provides the foundation for our observations. Debbie?

Sure. I'll add a couple of things. You mentioned the extension trade, and we do that within money markets as well. We started this cycle with weighted average maturities in the single digits to teens from a day’s perspective; we're now looking at much longer durations, around 30, 40, or 45 days. We have engaged in the extension trade to maintain higher yields within the product. Additionally, during the zero rate environment, many cash managers became accustomed to categorizing cash. A portion that is used for daily operations remains in the government sector, while more strategic investments move into prime, and then ultimately to Microshort—Ultrashort in the longest category. With a higher for longer scenario and a yield curve from overnight rates of about 5.25% to 5.30%, extending out to 10-year bonds at just under 5%, we are witnessing a market that is finally aligning with the Fed's statement on higher rates persisting. As Chris mentioned, we anticipate that flows will continue to grow in retail and will only increase in the institutional sector.

And Dan, it's Ray. I would just add that we're well positioned for individuals considering longer-term options with our fixed income product range. In particular, there is notable interest, as shown by the inflows in our total return bond Core Plus strategy, which has a six-year weighted average effective duration. It's in a strong position. We've been communicating with clients all year, and the cash yields are very appealing. There is definitely a wait for the right moment, but when that trade occurs, we have several strong strategies ready to attract funds moving further out.

And one more comment I had to, Ray’s bringing that up, and that is that the Ultrashort funds are starting to turn. They haven't gotten positive yet right here in this first couple of days of this month or quarter, but it's getting a lot closer. And the government Ultrashort Fund has just done a pretty good job on flow. So you're seeing people go out there. And remember, that's currently a $5 billion franchise that we have here and Ultrashort funds on all three streets.

That's very helpful. I wanted to follow up on distribution expense. You mentioned some of the dynamics in the quarter, but if you could provide a bit more detail about what happened and how we should consider the relationship between money market, AUM, and distribution expense going forward.

Okay, Dan, it's Tom. Probably, going forward, we would anticipate as assets go up, that distribution number would go up, and we had some changes in the quarter, as I mentioned, on product structures that reduce some of the revenue, but then reduced a pretty commensurate amount of expenses that should be cleared up. And I would expect if assets grow, that the distribution line item will go up as an expense.

Yes, Dan, the Q3 run rate is a good one to use going forward. It's down, as Tom noted, but also, as you know, to commensurate with the change in revenue. But that's a good run rate to use going forward.

Great. Thank you.

Your next question is coming from Patrick Davitt with Autonomous Research.

Hey, good morning, guys.

Good morning, Patrick.

You mentioned last quarter you thought the stock was cheap, and you had, I think, more than $400 million of available cash. So why not do more repurchase? And now that the stock is even cheaper. Should we be expecting more of that in 4Q?

That's a great idea.

We had our Board meeting yesterday, and we approved another $5 million share buyback program. This is our 16th program, and we have a history of completing these buybacks. Currently, we have about $1.5 million left in the existing program, and with only $1.4 million remaining, we wanted to secure approval for more shares.

Got it. Thanks. And another one on capital. Could you speak to any inorganic opportunities you're seeing right now? What kind of discussions are out there and what your appetite is to do more M&A at this point?

Yes, we have a strong interest in pursuing opportunities. We've been committed to paying our dividend and engaging in share buybacks for years. After the dividend, our primary focus is on acquisitions, not just one but multiple, as we believe this will yield excellent returns for the company. It has been difficult to persuade sellers to part with their businesses. While we continue to engage with potential sellers, I don’t have any announcements to make at this time. We are actively discussing larger deals, but those negotiations can take time, and I don’t have a specific list to share right now.

Thanks.

Your next question is coming from Ken Worthington with JPMorgan.

Hi, good morning. Thanks for taking the question. I wanted to expand on Dan's earlier question. So a number of CEOs have expressed the opinion that various investors are allocated to cash. So I guess, first, do you see retail and our institution over-indexed to cash versus other asset classes? And within cash, are they over-indexed to money market funds? So you talked about sort of the direct market, but how do you think money market funds stand today versus other cash channels? And are investors really over-indexed or not?

I don't have statistics good enough to make a judgment as to whether the retail clients are over-indexed to cash or not. The incidental information we get based on our sales force, which is robust, is that they are just very, very, very unsure about what to do. So that would mean they would have more money than the average bear would think in the money funds. But I don't have enough stats to tell you whether they are over-indexed to that. And we don't participate as vigorously as others do in this so-called cash sorting because the products we offer are the ones that give marketplace yield across the board. And I think that, that's about my response unless you have something, Debbie?

The only thing I'd add is that if you look at our money market fund assets a percent of our total liquidity assets, they are basically growing equally. It's about three-quarter money funds, one-quarter other types of whether it's in local government investment pools, separate accounts, collectives, privates, offshore, the rate of growth seems to be commensurate for both types of liquidity products. It doesn't seem like people are overweighting the money fund side of it.

Okay. Okay. Fair enough. And then Federated stock has underperformed quite a bit since it was announced that it would be excluded from the Russell indices. I guess how challenging would it be to adjust the structure to meet the minimum requirements for inclusion back in Russell? And given the magnitude of the stock underperformance, why not consider this?

Well, we're not going to do that. But I just can't connect coming out of the Russell to the performance of the stock. That's one of those post-hoc, ergo propter hoc mistakes. And I just can't buy into that. And in terms of the structure, we have a lot of confidence in the structure. We've been using it for a long time. And of course, considering same is not the same as committing it. So talking about it is fun. But I don't think it's going to happen.

Okay, fair enough. Thank you very much.

Your next question is coming from Brian Bedell with Deutsche Bank Securities.

Great. Good morning, folks. Thanks so much for taking my questions. First one, just back on the money market franchise. If I can squeeze in a two-parter on this one. One, from the retail behavior allocation side, so for the platforms that you're on in which you would be getting money market inflows from, say, risk-off allocations away from, say, equities. Is there any way to size what potential across your money fund base would be sensitive to those platforms? Maybe I'll start with that one.

We don't know.

Okay.

We can analyze the charts related to the assets in that field, but that won't provide a definitive answer to your question. Even if I show you the chart detailing the amounts in broker-dealer and retail, it still won't address your inquiry. Unfortunately, I don't have enough information to provide a complete answer.

Yes, I can say that for our largest distributors of retail products, retail money market funds, they're number one, very diverse; and number two, all experiencing large amounts of growth in the 2022, 2023 time frame. So it's not heavily weighted to 1 institution's preference or sales or allocation tactic. It's across distributions.

Okay, okay, fair. And is there a time for me to ask one more money fund question and also on ESG question?

Yes. Keep rolling.

Okay. Okay. Just one quick one on the money fund side. How you have been extending duration should we think of maybe a sort of a maximum extension if you think at some point, the market is going to start to price in rate cuts. And naturally, the longer you are extended the better, I guess, subject to liquidity constraints?

Generally, we aim for 10-day ranges. Currently, our prime funds are at 40 to 50 days, our government funds are at 35 to 40 days, and our municipal funds are also at 40 to 50 days. The maximum duration we anticipate reaching is 50 to 60 days. However, with the new daily and weekly liquid asset requirements set to be implemented in April 2024, it may be challenging to reach the mid to high-50s. Additionally, considering the potential for large clients wanting to exit, I would estimate that any extension might be limited to around 10 to 15 days, but not much beyond that.

Got it. Great. On the ESG side, as this year has progressed and considering the political challenges we've encountered concerning ESG, have you noticed any shifts in demand for the ESG funds you've launched? Additionally, can you compare the situation in the U.S. to what you're observing in Europe? How might this impact your future ESG product rollout strategy in both regions?

So Brian, I'll address that first and then let Saker discuss the European aspect. We conducted six years of cultural due diligence with Hermes from 2012 to 2018, focusing significantly on ESG. During that period, we dedicated a lot of time to ensure we could responsibly affirm our fiduciary duty concerning ESG. We have communicated this work to the SEC, the Department of Labor, and the marketplace, referencing a Stanford Law review article summarizing research that indicates fiduciaries must act in the exclusive financial interest of the investors. If someone wants an impact fund, that's acceptable as well, and ESG criteria can be utilized to assess risk to enhance returns. We believe this trend will persist. In light of current political developments and their implications for us, we strive to stay away from politics and focus on the fund's performance. A recent study by professors from University College Dublin, Oxford, and Texas at Austin found that engagement can minimize risk in a portfolio or individual security. That's a valuable point and reflects a fair debate in the marketplace where reasonable opinions may differ. However, we will maintain our integration efforts and continue enhancing performance as active managers. It's important to note that despite the ongoing debates in the U.S., there is a significant difference between the U.S. structure and that of Europe. I'll let Saker elaborate on his role internationally.

Thank you, Chris. Before we discuss our international efforts, I want to reiterate a point Chris made regarding our approach to ESG. We believe that integrating ESG enhances long-term financial returns. In the Hermes business, we consider ourselves a long-term institutional player, and our internal data supports the idea that this approach adds value over time. For us, this is about improving returns. Additionally, we incorporate engagement through our stewardship business, EOS. New studies support earlier findings that our engagement strategies can enhance financial returns. It’s important to note that we do not integrate ESG for non-financial reasons; our focus is solely on enhancing value and creating sustainable wealth. Unless specifically requested by clients, we do not divest from certain stocks. This is the guiding principle at Hermes, now Federated Hermes Limited. Chris noted that this approach aligns with fiduciary duties under U.S. law. In Europe, there’s an additional expectation—not just to pursue ESG for better returns, but also to create social impact. This trend is growing in various jurisdictions in Europe. We continue to see both demand and opportunities to expand our business there. I’d like to highlight that Hermes was among the pioneers in this field back in 1983, which gives us a long-standing perspective on our purpose. Our commitment to enhancing the interests of our investors strengthens our ability to roll out products outside the United States, where demand is on the rise. While the demand in Europe remains robust, it seems somewhat less pronounced in Asia, but we are observing increasing interest in the larger European market.

That’s great overview. Thank you so much.

Your next question is coming from John Dunn with Evercore ISI.

Thank you. Can you kind of characterize the sort of timing of the unfunded pipeline? How much is later stage versus newer wins and maybe the average time to funding?

Sure, John. I don't have statistics to give you on the quarters. But typically, you'll see the equity and fixed income fund in a couple of quarters and private markets can take as long as into next year because when we get those commitments when we have closings, the money often is not shown as assets under management until it's actually drawn down and investing. So we'd have to do some more work to give you kind of a weighted average timing on the pipeline, but generally look for the equity and fixed over the next couple of quarters and the private market to extend out several quarters.

Got you. And then maybe just thinking about strategic value dividend, can you give us kind of a flavor of the profile of the investor there? How they look at the current backdrop? And how the conversations of your wholesalers are going, holding on to assets versus like maybe increasing sales at some point?

Well, in terms of discussions, these are challenging discussions with the salespeople and the intermediaries that are in there. And so you've got to be straightforward about that, but it simply repeats what we said all along, and the fund continues to do what it does. So even though it's like a pogo stick in terms of Morningstar category that it doesn't really fit going from the top to the bottom, bottom to the top, that's what stimulates the discussions. And so we've been through this before. And that keeps a lot of the core shareholders quite sanguine because they're looking at a 5%-plus yield on a bunch of stocks that are pretty solid. Now they're not the magnificent 7%, so you're not going to get that ride. So it is an active debate and an active discussion.

Thank you.

Your next question is coming from Michael Brown with KBW.

Great. Thank you. Tom, I just wanted to dive into the expenses a little bit. I appreciate the commentary about the quarter. But given some of the puts and takes you mentioned, I just was looking to maybe clarify some forward thoughts on the non-comp side, particularly on the G&A side is what you saw in the third quarter a reasonable run rate for the fourth quarter? Should we expect that to kind of step down? And then when I look out to 2024 based on your growth and investment expectations and view on what the expense growth rate could be for that G&A line, in particular, just given that might be a bit better or easier to predict. And could that come back to like a mid-single-digit growth range?

Okay, Mike. We noted that the compensation line included about $10 million related to carried interest. Without additional carried interest in the fourth quarter and beyond, that number would decline, assuming everything else remains constant. I've previously refrained from predicting the compensation line because it's unpredictable. Regarding distributions, we've discussed that the run rate is solid, and we anticipate an increase if assets rise. Advertising and promotion expenses are stable and may see a slight increase in the fourth quarter as we ramp up our efforts in that area. Other line items appear to be on track for stable run rates. The other line includes foreign exchange impacts. We hedge since we earn our fees in dollars while compensating staff in London in pounds. A decline in the pound could lead to higher expenses, but our hedging strategy mitigates that risk. After going through infrastructure restructuring, those costs should decrease slightly. Overall, I don't have much to add for 2024. We're entering budget season, and I am hesitant to forecast for next year.

Okay. And maybe just one follow-up on the M&A comment earlier. It sounds like you're having some active dialogue looking at interesting opportunities out there. Could you just give us a flavor of what would be kind of some interesting additions to the Federated Hermes platform? What types of assets could be a good fit for your company? And then in terms of maybe size, would you think a deal would be kind of closer to a CW Henderson, so maybe more of a bolt-on? Or do you think that there's potential for something more transformative?

We are really excited about Henderson as we approach our one-year anniversary there. We anticipate some promising developments because the budgeting process has begun, which gives us hope for growth. This size of transaction aligns well with us; we can integrate it into Federated, leverage the expertise of the teams involved, and enhance our distribution capabilities. We're looking for more opportunities like that. As we discussed last quarter, while it may seem like just talk, we are focused on taking our expertise from London and expanding it in the U.S. We're continuously exploring possibilities, though I wouldn't classify these as transformational deals. Rather, they are about how we can combine our skills with local teams to enhance our presence in real estate, private equity, infrastructure, and private debt, where we see strong growth opportunities in London. Unless something particularly appealing arises, I wouldn't anticipate any significant transformational deals, but we remain open to exploring any opportunities that come our way.

Great. Thank you. Appreciate all the color.

We have reached the end of the question-and-answer session, and I will now turn the call over to Ray for closing remarks.

Thank you, Holly. That concludes our call, and we thank you for joining us today.

Thank you. This does conclude today's conference, and you may disconnect your lines at this time. Thank you for your participation.