Good day, and welcome to the FHI Q4 2022 Analyst Call and Webcast. At this time, all participants have been placed on a listen-only mode. The floor will be open for questions and comments following the presentation. 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 Donohue, Federated Hermes CEO and President, Tom Donohue, Chief Financial Officer. 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. 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 and our SEC filings. No assurance can be given as to future results. Federated Hermes assumes no duty to update any of these forward-looking statements. Chris.
Thank you, Ray. Good morning, all. I will review Federated Hermes business performance. 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, 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 the Q4, with about a quarter of that from the fund and almost three-quarters of that 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. 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.
For the first 3 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 C.W. Henderson acquisition of about three and a half billion and gains from market values of about $1 billion and 6 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 Microshort 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 $1,000,000,008 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 3 years, 57% of our fixed income funds were beating peers, and 16% were in the top quartile of their category. For the first 3 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 excess FX impact, partially offset by market losses and net redemptions. Pru-Lev was up, MDT was up, and direct lending was up. These were offset by net redemptions in absolute return credit, private equity, and infrastructure.
We continue marketing the 5th vintage of PEC, our co-investment private equity structure, and the 3rd vintage of the Horizon Private Equity Fund. PEC V has raised about $400 million through year-end, 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 benefiting 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 as 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. Tom?
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 interests were $3.3 million. Q4 operating expenses increased $25.8 million or 9% compared to Q3, driven by the $31.5 million non-cash intangible asset impairment charge, offset mainly by FX impact of $8 million from the currency forwards used to hedge certain GBP 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 non-operating income, investment gains after subtracting the impact attributed to the non-controlling 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. 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, 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. Non-taxable, non-controlling interest income that's included in our pre-tax 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%-26% in 2023. At the end of 2022, cash and investments were $522 million, of which about $466 million was available to us. Holly would now like to open the call up for questions.
Certainly. At this time, we will be conducting a question-and-answer session. If you have any questions or comments, please press star one on your phone at this time. We ask that while posing your question, you please pick up your handset if listening on speakerphone to provide optimum sound quality. Please hold while we poll for questions. Your first question for today is coming from Dan Fannon at Jefferies. Dan, your line is live.
Hi. Good morning. This is actually Rick on for Dan. Just thinking about expenses, how should we think about the general trajectory for non-comp expenses? Also kind of double-clicking into that, I believe the other line, you know, excluding the impairment charge, was lower by approximately $5.5 million or around that range compared to the last 3 quarters and a year ago. Just wondering, was that sort of the FX impact, or, you know, FX impact in the other direction that was called out, or is this sort of, run ratable savings? Yeah.
Yeah, Dan. I'll cover some of those. Ray will come in with a few more. I mentioned the comp already. You know, all else being equal, we expect that to go up. Distribution, we would expect that to go up. We see that as a, you know, in the old days, a success item. As we get more assets, distribution goes up. Systems and communication, professional service fees, travel-related, you know, those all have inflation and price increases. All I expect to go up. You want to comment on the other?
Yeah, Rick, you're correct with the FX impact. you know, obviously we saw pretty significant movement in the pound in Q3, and so we had a net expense in that line item. Then for Q4, with the pound moving the other direction, we had a net credit that was the $8 million that we mentioned.
Got it. I appreciate that color. 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, you know, general levels as a % of revenues, or, you know, is there a better way to think of that?
Yeah. We don't look at it like that at all. We just don't calculate it based on that way and don't think that way. We're trying to raise assets. What's the best way to do it? Like, for T&E, the sales force believes they should be out there. You know, you can see that trending up. It's trending up, and they're out there traveling more, and it costs more to do it. We don't calculate it the way you're talking about.
Understood. Appreciate that. If I could sneak one last question in there. In terms of long-term fee rate, just, and sort of the quarter date kind of flow discussion that was called out, how does the exit rate for the fourth quarter kind of compare to the average, and how does that look like going into, you know, early January?
The fee rate really is a function of the blend of changes in assets. You've seen, you know, for example, in equity over the course of 22 with growth assets being down, you know, to cite one example, that would be a case where we would have higher than the average, higher than our average fee rates. In addition, we've had growth in, we called out the Strategic Value Dividend SMA. SMAs, of course, have lower management fee rates than the mutual funds do. It's really a function of the blend of where the average asset growth is occurring.
You know, looking at the first couple weeks of 23, I would say I wouldn't use that to forecast any material change in the fee rate. We'd wanna cover some more ground before doing that. They're good, solid wins, you know, in categories like high yield, multiple, you know, most of the equity products producing net positive flows. Of course, we've had positive market impact. All of that goes to the good.
Thanks, guys. Really appreciate the color.
Your next question for today is coming from Patrick Davitt at Autonomous Research. Patrick, your line is live.
Hi. Good morning, everyone. 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? I guess more broadly on that point, has your view on the opportunity for growth there changed in some way?
Yeah, Patrick from Autonomous. The cash flows, you know, we have to go through, I think there's six different categories when we did the deal. You know, this is one category, the public markets. Since the deal, if you look at it from a, you know, since 2018, the assets and particularly more recently, the asset declines. Then we have to go through and look at forecasts. Predicting the future, we just had to scale those back. Then the discount rates, of course, rates has gone up since we did the deal. When you kind of take the whole picture on a long-term basis, we had to have an impairment. It's just on an accounting basis, pretty simple.
In terms of excitement with what's going on with Hermes, you know, I think a number of things that Chris mentioned in our pipeline are pretty exciting. I think Saker ought to give a comment on the exciting things that we still see happening there.
Thank you very much, Tom. I mean, let's start just with some of the stuff that you heard from Chris. If you remember, he said that $4.8 billion of net institutional manage are yet to fund, but these are signed and yet to fund. The majority of these actually are coming in into Federated Hermes Limited, which is in London, which is the old Hermes business. That gives you an idea of the strength of growth. Of that, for example, you know, if you talk about the equity strategies, well over a billion, $1.3 billion, is in Asia ex-Japan.
You've got further $270 million going into global emerging markets, another $117 million going into global equities, and then some more into fixed income and SDG high yield of around $290 million. Add to which you can add private equity, which is over $1.3 billion. You have a very exciting picture based on the future positivity that we see. I mean, yes, one swallow does not a summer make, but it tells you the strength that's here looking forward. Now, why is that? Two reasons.
One is, yeah, of course, since 2018, from an accounting perspective, you've got to look at the fact the markets went down, there was COVID, and there was the Ukraine War, and we have a lot of growth assets or growth equities in our public markets. Actually, they're much in demand. We've seen that even through the tough last years, and it looks as if this is going to continue to grow for us. The proof of the pudding is within public markets is we're continuing to invest, particularly in sales. We're looking at offices in other parts of Continental Europe than the ones we've got. We've talked about offices there, at least 1 that's going to be established this year, possibly 2.
That means that we increase our capability to distribute within the mainstream European market. If you go to private equities, which is where we. Sorry, I beg your pardon. With private markets, there's private equities, which includes private debt. That has been very exciting with lots of flows through all through last year. Strength, seeing this year with a lot of interest from our clients. An excellent environment for our kind of strategy. If you go to our private equity, again, we're seeing lots of excitement from our clients. That's good. Of course, our property is a long-term play which continues to chug along. For that, we're investing in... For that, I mean, for private markets as a whole, we're investing into a dedicated sales force to work alongside our generalist sales force to help increase that. There's lots of exciting things happening here in London. If I look at the future and the growth, I'd say that it's very much here and it's, it'll come through, notwithstanding that last year was obviously a difficult year, as we all know, because of the reasons that we do know. I'm not gonna comment on accounting. That's Tom's job to do accounting. I'm a fund manager, and I look for the future, and the future in this looks exciting to me.
Helpful. Thanks. Just a quick follow-up. Could you give the performance fee number for the quarter?
It's $3.3 million.
Thank you.
That's performance fee and carried interest.
Got it. Thank you.
Your next question for today is coming from Mike Brown at KBW. Mike, your line is live.
Great. Good morning. wanted to start on the, maybe on the balance sheet here. I guess the buybacks were lower in the quarter, but I did notice that your cash position has grown meaningfully. It stands at more than 25% of assets. How are you thinking about your cash levels and capital allocation more broadly? Could we see a return to buybacks or a special dividend here?
Yeah, the cash has grown. It's spectacular since we raised the long-term debt at what we view a very favorable rate. You know, we bought back, pretty significant amount of shares. We historically have not wanted to hold on to cash. Now, you know, starting new products has become more expensive, i.e., more investing is needed. That's kind of a demand for, you know, resources to have seed assets. You know, on a long-term basis, we have not been a group to hold on to the cash. We will see. We wanna do acquisitions. That has been our first, you know, desire with the use of the money 'cause of our re-returns on them. We of course have the regular dividend.
As you know, we paid five special dividends. We've bought back a lot of stock. All those are on the table for us to figure out what to do with the cash with no timetable and not trying to lead you to we're going to do this or this or this.
Well, one other point I'd mention here is that even though earnings are down on account of the impairment, we still have cash available to do a lot of the things Tom Donohue said, which I would phrase as investing for the future. This means putting money into the platform in the private equity area over at 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. Tom Donohue mentioned the fact that investments in seed assets, those are running at about $140 million. Again, the same number, obviously not related. So those are worthy interests of cash, but they all point to building for the future.
Great. Thank you. If we could just switch gears to the flows. The Ultrashort Fixed Income flows, can you just expand on what drove the outflows there? What's some of the investor dynamics that caused that to happen? On the money market side, it sounds like you're basically just down a little bit, in totality from the 4Q EOP levels, but the mix has shifted a little bit. Any additional color you can put around that? You know, what's kind of driving the growth of the SMAs, and is that more sticky than the fund side, which sounds like it benefited from some seasonality in 4Q?
I can start to answer those questions. From an Ultrashort perspective, and it definitely pertains to, you know, where we are from an interest rate standpoint in the marketplace. Interest rates continued to go up in the fourth quarter, you know, 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, you know, see flows going in the opposite direction. Those flows can, you know, come out of, you know, the institutional side, the retail side, corporate.
There's, you know, generally speaking, a broad-based exit that has slowed down as the year has progressed. In products even like micro shorts, you know, that actually got money in, that it that basically is offsetting some of what we're seeing in the, you know, sort of a little bit further out the yield curve, 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 0 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, you know, 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, has continued on a percentage basis to offset those flows in a pretty decided way.
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. It has a regular pattern of increasing when tax receipts are made at year-end, you know, through the middle of the second quarter, typically. That tends to go down over the latter half of the year. 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, you know, with those clients to increase utilization of those pools.
Okay, great. Thank you for taking my questions.
Your next question for today is a follow-up question coming from Patrick Davitt. Patrick, your line is live.
Hey, thanks for the follow-up. Just on the back of that question, I asked a similar question last quarter. You know, 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 big rotation is coming this year? What milestones are you really looking for 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. 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, you know, let's call it a 1-month lag versus the direct market. 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. The caveat to that is that they're not going to zero, that they're, you know, going from 5 to 4 to 3, somewhere in that neighborhood.
In those cases, that's when much more outsized growth generally happens from an industry and, you know, 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 they're still very large. Again, 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. You know, 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.
Compare that to where we are from a fund yield perspective, which is, you know, essentially all north of 4% and heading towards 5%, vastly different. Being $1 trillion down in deposits, is just sort of a drop in the bucket. The expectation would be that will continue to fuel outflows, you know, with that deposit beta being lower. A very natural recipient of those outflows would be money market funds.
If I can indulge this history, which I've used before, Patrick, I think it's informative. The Fed increase that was Q4 2016 to Q4 2018, we had a little pause, 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%. You go to the next one, our assets went up about 22% through the third quarter of 2019, and the industry at that time did about 14%. You know, 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, the overall situation with others' clientele. Naturally, we have a lot of the same ones, but it matters a lot if you have a lot of trust departments, a lot of intermediaries and things like that.
Very helpful. Thanks.
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.