Good day, and welcome to the FHI Q4 2022 Analyst Call and Webcast. It is now my pleasure to turn the floor over to your host, Ray Hanley, President of Federated Investors Management Company. Sir, the floor is yours.

Good morning, and welcome. Leading today's call will be Chris Donahue, Federated Hermes' CEO and President; Tom Donahue, Chief Financial Officer. And joining us for the Q&A are Saker Nusseibeh, who is the CEO of Federated Hermes Limited; and Debbie Cunningham, the Chief Investment Officer for Money Markets. 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 our 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. We ended 2022 with record total assets under management of $669 billion. This was driven by growth of $35.6 billion in money market assets in Q4 to reach a record high of $477 billion at year-end. Turning to equities, assets increased by about $7 billion to $81.5 billion due to market gains, FX impact, and net positive sales in separate accounts, all of which were partially offset by net fund redemptions. The strategic value dividend strategy continued to produce solid net sales with nearly $1 billion in Q4, with about a quarter of that from the fund and almost three-quarters from the SMA. The U.S. strategic value dividend ETF launched in mid-November now has $42 million in assets. We saw Q4 positive net sales in 16 equity fund strategies, including Asia ex Japan, International Strategic Value Dividend, MDT Large Cap Growth, European Alpha Equity, International Growth, and Clover Small Value. Q4 equity fund net redemptions of $1.4 billion were concentrated in our growth strategies. Our equity fund performance at the end of 2022 compared to peers was solid. Using Morningstar data for the trailing three years, at the end of the year, 61% of our equity funds were beating peers, and 33% were in the top quartile of their category. As we begin 2023, our equity focus with clients continues to be on the strategies that have responded well in inflationary times. These include dividend income, international, emerging markets, and value. Now for the first three weeks of Q1, combined equity and SMAs had net positive sales of $328 million. We had 23 equity funds with positive net sales during this period, including strategic value dividend, global emerging markets, Asia ex Japan, MDT Small Cap Core, and international leaders. Turning now to fixed income, assets increased by about $1.3 billion in Q4 to $86.7 billion as assets from the CW Henderson acquisition of about $3.5 billion and gains from market values of about $1.6 billion were partially offset by net redemptions from funds of $2.6 billion and separate accounts of $1.3 billion. Within our funds, our flagship Core Plus strategy, total return bond had Q4 net sales of about $652 million, benefiting from a long-term performance record, and that has led to expanded distribution opportunities. Our two micro short bond funds combined for just under $200 million of Q4 net sales. Core Plus and other multi-sector fixed income SMA strategies added $146 million of Q4 net sales. Within fixed income funds, Q4 net redemptions of about $1.8 billion occurred in the three ultrashort funds. We had nine fixed income funds with positive net sales in the fourth quarter, including Total Return Bond and two micro shorts, as already mentioned, as well as Institutional High-Yield Bond Fund and the Intermediate Corporate Bond Fund. Regarding performance, at the end of 2022, using Morningstar data for the trailing three years, 57% of our fixed income funds were beating peers, and 16% were in the top quartile of their category. For the first three weeks of 2023, fixed income funds and SMAs had net positive sales of $466 million, led by Total Return Bond and SDG Engagement High-Yield Credit. During the same period, we had 18 fixed income funds with positive net sales. Some of the others include Corporate Bond, Sterling Cash Plus, and Institutional High-Yield Bond. In the alternative and private markets category, assets increased due to positive FX impact, partially offset by market losses and net redemptions. Pru Bear was up, MDT was up, and direct lending was up. These were offset by net redemptions in absolute return credit, private equity, and infrastructure. Now we continue marketing the fifth vintage of PEC, our co-investment private equity structure, and the third vintage of the Horizon Private Equity Fund. PEC 5 has raised about $400 million through year-end, and Horizon has commitments of a little over $1 billion through year-end. We begin 2023 with about $4.8 billion in net institutional mandates yet to fund into both funds and separate accounts. About $3 billion of this net total is expected to come into private market strategies, including private equity, direct lending, and unconstrained credit. Equity wins of about $1.3 billion are in Asia ex Japan, global emerging markets, global equities. Fixed income expected additions are in SDG High-Yield Credit, Investment-Grade Credit, and Short Duration. Moving to money markets, the Q4 asset increase reflected seasonality and favorable market conditions for cash as an asset class. Money market strategies are benefitting from higher yields, elevated liquidity levels in the financial system, and favorable yields compared to bank deposits. We expect higher short-term rates will benefit money market funds over time, particularly compared to deposit rates. Our money market mutual fund market share, including the sub-advised funds, was about 7.7% at the end of 2022, up from about 7.4% at the end of the third quarter of 2022. Looking now at recent asset totals as of a few days ago, managed assets were approximately $674 billion, including $475 billion in money markets, $90 billion in equities, $85 billion in fixed income, $21 billion in alternative private markets, and $3 billion in multi-asset. Money market mutual fund assets were $325 billion.

Thanks, Chris. Total revenue for Q4 decreased $7.2 million or about 2% from the prior quarter, due mainly to lower average long-term assets and lower performance fees and carried interest, partially offset by higher average money market assets. Q4 performance fees and carried interest were $3.3 million. Q4 operating expenses increased $25.8 million or 9% compared to Q3, driven by the $31.5 million noncash intangible asset impairment charge, offset mainly by FX impact of $8 million from the currency forwards used to hedge certain pound exposure. The impairment charge was due to the change in fair value of one of the intangible assets from the 2018 Hermes Fund Managers Limited acquisition, representing about 6% of the total acquisition price. The lower asset valuation was driven by changes in projected cash flows and a higher discount rate compared to the prior quarter. In nonoperating income, investment gains after subtracting the impact attributed to the noncontrolling interest added earnings per share for the quarter of about $0.04 due to the positive impact of the market on the investments. Looking ahead to Q1, certain seasonal factors will impact results. The impact of fewer days is expected to result in about $6.4 million in lower operating income, excluding the impact of the impairment charge and with all else being equal. In addition, based on an early assessment, compensation and related expense could be $13 million higher than Q4, due primarily to about $9 million of seasonally higher expense for stock compensation and payroll taxes. We also expect to have higher base pay and higher incentive compensation expense. And of course, all these amounts will vary based on multiple factors. The effective tax rate was lower in Q4, primarily related to a one-time recognition of a capital loss for tax purposes, nontaxable, noncontrolling interest income that's included in our pretax income but not taxable to Federated Hermes, and certain stock-based compensation where we get a higher tax deduction when our stock price at vesting exceeds the price when the shares were granted. We expect our effective tax rate to be in the range of 24% to 26% in 2023. At the end of 2022, cash and investments were $522 million, of which about $466 million was available to us. Holly, with that, I would now like to open the call up for questions.

Your first question for today is coming from Dan Fannon at Jefferies.

This is actually Rick on for Dan. Just thinking about expenses, how should we think about the general trajectory for non-comp expenses? And also kind of double-clicking into that, I believe the other line, excluding the impairment charge, was lower by approximately $5.5 million or around that range compared to the last three quarters and a year ago. Just wondering, was that sort of the FX impact or FX impact in the other direction that was called out? Or is this sort of run rate of all savings? So yes.

Rick, I'll cover some of those; Ray can come in with a few more. So I mentioned the comp already. So all being equal, we expect that to go up. Distribution, we would expect that to go up. We see that as the old days as a success item as we get more assets, distribution goes up. Systems and communications, professional service fees, travel-related. Those all have inflation and price increases, all I expect to go up. And you want to comment on the other?

Yes, Rick, you're correct with the FX impact. And obviously, we saw pretty significant movement in the pound in Q3. And so we had a net expense in that line item. And then for Q4, with the pound moving in the other direction, we had a net credit that was the $8 million that we mentioned.

Got it. I appreciate that color. And then just on sort of the higher expenses that you called out, could you point to maybe a pre-pandemic sort of year or set of quarters that we can look at for general levels as a percent of revenues? Or is there a better way to think of that?

We don't view it that way at all. Our approach to calculations is different, and our focus is on raising assets. We are exploring the best strategies to achieve that. Regarding travel and expenses, our sales team believes that increased travel is essential, and we have seen an upward trend in that area, which comes with higher costs. However, our calculations do not align with your perspective.

Understood. I appreciate that. If I could ask one last question, regarding the long-term fee rate and the quarter-to-date flow discussion that was mentioned, how does the exit rate for the fourth quarter compare to the average? And what does that look like going into early January?

The fee rate is primarily influenced by the mix of changes in assets. For instance, in 2022, with a decline in growth assets, we experienced higher fee rates compared to our average. Additionally, we've seen growth in the strategic value dividend SMA, which typically has lower management fees than mutual funds. Therefore, the fee rate is determined by where the average asset growth is happening. Looking at the first few weeks of 2023, I wouldn't expect any significant changes in the fee rate just yet, as we would need more data before making such forecasts. There have been positive movements in categories like high yield, and most equity products are seeing net positive flows, along with favorable market effects. All these factors contribute positively.

Your next question for today is coming from Patrick Davitt at Autonomous Research.

So my first question is on the Hermes impairment. Could you give a little bit more detail on the changes that went into the cash flow downgrades? Are there some products that are not working out as planned? And I guess, more broadly on that point, has your view on the opportunity for growth there changed in some way?

Yes, Patrick from Autonomous. We need to review the cash flows, which fall into six different categories from the deal, and this is one category related to the public markets. Since the deal, particularly since 2018, there have been asset declines, and we need to look at forecasts and predict the future. We've had to scale those back, and the discount rates have increased since the deal was made. So, when we assess everything on a long-term basis, we needed to recognize an impairment based on our accounting practices, which is straightforward. Regarding the developments with Hermes, several items that Chris mentioned in our pipeline are quite promising. I believe Saker can elaborate on the exciting opportunities we still see there.

Thank you very much, Tom. Let's start with some of the information shared by Chris. He mentioned that $4.8 billion of net institutional mandates are pending funding, but these agreements are ready to go. Most of these are directed to Federated Hermes Limited in London, the former Hermes business, highlighting our growth strength. For instance, in equity strategies, there is over EUR 1 billion, specifically EUR 1.3 billion in Asia excluding Japan. Additionally, there is $207 million allocated to global emerging markets, about $117 million to global equities, and approximately $290 million into fixed income and high yield. On top of that, private equity stands at over $1.3 billion, painting a promising future ahead. While one instance doesn't indicate a trend, this reflects our strong outlook. There are two main reasons for this optimism. First, since 2018, we’ve faced market downturns and challenges like the Ukraine war, impacting our growth assets in public markets. Despite last year's struggles, the demand for these assets remains robust and appears likely to grow. We're actively investing, particularly in sales, and exploring office spaces in different regions of Continental Europe, with plans for at least one, possibly two new offices this year. This expands our distribution capabilities in mainstream European markets. Regarding private markets, which encompasses private equity and private debt, we've seen significant inflows over the past year and strong client interest, creating a favorable environment for our strategies. Our property investments are also steady and long-term. We're committing to a dedicated sales force to enhance our efforts in private markets. Exciting developments are underway in London. Looking ahead, I see substantial growth potential despite last year's challenges, which are well understood. I'm focused on the future, and it looks promising to me.

Helpful. Just a quick follow-up. Could you give the performance fee number for the quarter?

$3.3 million. So that's performance fees and carried interest.

Your next question for today is coming from Mike Brown at KBW.

I want to start by discussing the balance sheet. The buybacks were lower this quarter, but I noticed your cash position has increased significantly and now represents over 25% of assets. How are you approaching your cash levels and capital allocation overall? Is there a possibility we might see a return to buybacks or a special dividend?

Yes, the cash has increased significantly since we raised long-term debt at what we consider a very attractive rate. We've also repurchased a substantial amount of shares. Historically, we've not preferred to hold onto cash, but launching new products has become pricier, which requires more investment as we need seed assets. However, long-term, we are not a group that typically retains cash. We are looking to make acquisitions, which is our primary goal for utilizing these funds due to the returns we expect from them. We also maintain a regular dividend; as you know, we've distributed five special dividends and have repurchased a considerable amount of stock. All options are available to us regarding our cash management, with no set timeline, and we are not trying to suggest a specific course of action at this moment.

One other point I'd mention here is that even though earnings are down on a kind of the impairment, we still have cash available to do a lot of the things Tom said, which I would phrase as investing for the future. This means putting money into the platform in the private equity area over the U.K. It means $140 million worth of commitments in technology that doesn't hit income in any one year, as you all know. And Tom mentioned the fact that investments in seed assets, those are running at about $140 million. Again, the same number, obviously not related. And so those are where the interest of cash, but they all point to building for the future.

Great. If we could shift our focus to the flows, can you elaborate on the factors that led to the outflows in the Ultrashort fixed income? What are some of the investor behaviors that contributed to this situation? Regarding the money market, it appears that overall, you're slightly down from the end of the fourth quarter, but there has been a change in the mix. Can you provide more details on that? What is fueling the growth of the SMAs, and are they more stable compared to the funds, which seem to have taken advantage of some seasonal trends in the fourth quarter?

I can start to answer those questions. From an ultrashort perspective, it definitely pertains to where we are from an interest rate standpoint in the marketplace. Interest rates continue to go up in the fourth by 75 basis points and then again, 50 basis points in December. The expectation is they'll continue to go up more modestly, but hold at a higher level in 2023. When you see that sort of increase in rates in the marketplace, generally, anything outside of liquidity products, i.e., money market products or cash are going to see flows going in the opposite direction. Those flows can come out of the institutional side, the retail side, corporates. So there's, generally speaking, a broad-based exit that has slowed down as the year has progressed. And in products even like Microshort that actually got money in, that's basically offsetting some of what we're seeing in the sort of a little bit further out the curve of the ultrashort types of products. From a money market fund perspective, the mix continues to be obviously predominantly in the government sector. However, where we experienced on a percentage basis, the most amount of growth during 2022 was in the prime and muni sectors, and that's simply a result of being above zero at this point, and therefore, the spread between government and those other categories widening out as interest rates themselves have increased. When you look at it on a quarter-over-quarter basis, the fourth quarter always has a huge amount of inflows, not always, but for the most part, has a large amount of inflows in the second half of December, let's call it, it's window dressing as well as tax purpose issues that many firms are trying to do. Ultimately, this results in inflows into the government, in particular, money market funds during the second half of December, some of which then goes out. Generally, the first quarter of 2023 sees outflows out of those products. Because of increasing interest rates, however, the other categories, Prime in particular, have continued on a percentage basis to offset those flows in a pretty decided way.

And Mike, just on the separate account growth into January, you mentioned some seasonality there, and that does come into play. That category of asset for us is dominated by large state cash pools that we manage. And so it has a regular pattern of increasing when tax receipts are made at year-end through the middle of the second quarter, typically. And then that tends to go down over the latter half of the year. But it's fallen, it's reached higher highs and higher lows. We've had a lot of underlying success, both because of a favorable macro for money market yields and also some effective work that we've done with those clients to increase the utilization of those pools.

Your next question for today is a follow-up question coming from Patrick Davitt.

Just on the back of that question, I asked a similar question last quarter. But we keep hearing from some of your competitors that there is an expectation of a bigger surge into money fund flows from, say, deposits. I know there's always some seasonality noise from December to January, but are you still of the view that that big rotation is coming this year? And what milestones are you really looking for that to really pick up?

Sure, Patrick. Generally speaking, when interest rates are increasing because money funds have a weighted average maturity that's something greater than a day, they lag the direct market. And so for many of our institutional clients that have the capability of going into the direct market, they might do just exactly that. Rather than go into money market funds that are increasing but are increasing with, let's call it, a one-month lag versus the direct market where money funds generally start to excel and exceed from a growth perspective is when interest rates have kind of reached a plateau and when they start going back down the other side. Now the caveat to that is that they're not going to zero, that they're going from five to four to three, somewhere in that neighborhood. In those cases, that's when much more outsized growth generally happens from an industry and from our own experience here at FHI. Versus the deposit market at this point. Overall, deposits in the U.S. are down about $1 trillion, but the very large. Looking at the rates on deposits versus the rates on money market funds, they have increased during the first quarter. We're up to about 38% from a deposit beta perspective versus what's happening in the direct market, the Fed funds market. So 38% of the increase is being captured in deposits. As such, I think the average deposit rate for the fourth quarter was up to about 70 basis points. But compare that to where we are from a fund yield perspective, which is essentially all of 4% and heading towards 5%, vastly different. So being a trillion down in deposits is just sort of a drop in the bucket. The expectation would be that will continue to fuel outflows with that deposit beta being lower and a very natural recipient of those outflows would be money market funds.

And if I can indulge this history, which I've used before, Patrick, I think it's informative. The Fed increase that was Q4 '16 to Q4 '18, we had a little pause, and then our money market assets increased by 15% from about $210 billion to $240 billion. The industry followed a very similar pattern. They were up 11%. Naturally, we were up 15%. Then you go to the next one, our assets went up about 22% through the third quarter of '19, and the industry at that time did about 14%. So depending on how big people are talking about numbers, those are what happened. The next point I would make is that it matters a lot who your clients are and what is their history. We have unique clients; others have unique clients. And I can't comment on the overall situation with others' clientele. And actually, we have a lot of the same ones, but it matters a lot if you have a lot of trust apartments, a lot of intermediaries and things like that.

There appear to be no further questions in queue. I would like to hand the call back over to Ray Hanley for any closing remarks.

Well, thank you. That concludes our call, and we appreciate you joining us.

Thank you. This concludes today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.