FEDERATED HERMES, INC. Q3 FY2026 earnings call

• Equity Performance: The firm achieved record equity AUM with strong performance rankings; 56% of equity funds beat peers and 33% were in the top quartile over trailing three years. MDT fundamental quant strategies led sales with record gross and net inflows.
• Fixed Income Dynamics: Despite net positive fund sales, fixed income AUM declined due to significant client redemptions, including a $1.7 billion withdrawal from a multi-sector mandate as the client shifted risk profiles.
• Money Market Strategy: Management emphasized a strict bias toward daily liquidity at par, refusing to extend maturities for incremental yield. This conservative approach contributed to seasonal outflows but preserves stability against market volatility.
• Digital Asset Infrastructure: Federated Hermes is building foundational infrastructure for tokenization through partnerships with Prometheum, BNY Mellon, ArchEx, and Conduit Digital. Management clarified that this is a long-term readiness play rather than an immediate revenue driver, as client demand is not yet overwhelming.
• Institutional Pipeline: The firm entered Q4 with a robust $6.5 billion institutional pipeline, diversified across various equity strategies (large cap, small cap, core) and private markets, indicating strong underlying demand despite mutual fund headwinds.

Federated Hermes reported total managed assets of approximately $890 billion at the end of Q3. Equity assets reached a record $112 billion, up from $110.5 billion in Q2, driven by positive net inflows partially offset by lower market valuations. Fixed income assets stood at $98 billion, down from $99 billion in Q2 due to redemptions and valuation decreases. Alternative private markets assets increased slightly to $21.7 billion. Money market assets decreased by 4% to $654 billion, impacted by Federal Reserve rate hikes and corporate tax payments. Multi-asset assets were reported at $3 billion.

• Q4 Net Flows: Management expects equity strategies to generate approximately $7 billion in net sales, primarily from MDT additions. Private markets are expected to see net inflows of approximately $1.2 billion. Conversely, fixed income is projected to experience net redemptions of about $1.7 billion.
• Financial Metrics: The effective tax rate for full-year 2026 is estimated to be between 25% and 28%. Operating margins are expected to remain above 30%, supported by expense discipline.
• Expense Outlook: Compensation expenses are anticipated to rise in Q4 due to continued growth. Distribution costs will track money market asset levels, while systems and communications spending remains elevated.

• Liquidity and Rate Sensitivity: Money market assets are highly sensitive to Federal Reserve interest rate changes and seasonal liquidity events like corporate tax payments, which caused a 4% decline in Q3.
• Client Concentration and Redemption Risk: Significant redemptions occurred in key fixed income mandates, such as the $1.7 billion exit from a total return bond strategy, highlighting vulnerability to large institutional shifts in risk appetite.
• Fee Compression: Large institutional wins, particularly sub-advised mandates and separate accounts, carry lower fee rates than traditional 40 Act mutual funds, posing a risk of diluting the blended fee rate despite volume growth.
• Regulatory and Operational Complexity: Expanding into digital assets involves navigating complex regulatory frameworks and partner dependencies, with no guarantee of near-term commercial traction or accelerated adoption.

Q: Why did Federated Hermes experience significantly larger outflows compared to competitors like BlackRock and JP Morgan, and is this driven by pricing competition? / A: CEO Chris Donahue attributed the gap to routine short-term portfolio construction adjustments rather than structural issues. CIO Debbie Cunningham explained that the firm maintains a strict bias for daily liquidity at par, refusing to extend security maturities for marginal yield gains. This conservative stance sacrifices some competitive positioning during periods of high yield seeking but ensures true daily liquidity, preventing the 'walk-out' risks seen in competitors who chase higher yields.

Q: How sustainable are the current expense controls, and what is the outlook for compensation and other costs in Q4 and 2027? / A: CFO Tom Donahue noted that while he provided no specific guidance for 2027, he expects compensation expenses to rise in Q4 as the firm continues to grow. Distribution costs will fluctuate with money market asset levels, and spending on systems and communications remains elevated. However, most other expense lines are expected to remain stable, supporting the maintenance of operating margins above 30%.

Q: Does the partnership with Prometheum accelerate the tokenization of non-money market funds like NDT, and where does digital fit in the strategic roadmap? / A: CEO Chris Donahue stated that the deal does not accelerate immediate tokenization efforts but rather builds necessary infrastructure for future capabilities. He emphasized that clients are not currently demanding these products, so the focus is on preparing the ecosystem. Liquidity-focused products remain the priority, with other securities following later, ensuring the firm is ready for eventual adoption without forcing premature product launches.

Q: Is there a bifurcation between asset share and revenue share in money markets, and how does the firm view tax-aware long-short strategies? / A: Management acknowledged they cannot calculate precise revenue market share but inferred that their retail-intermediary channel performs better on fee rates than pure asset share metrics would suggest. Regarding tax-aware long-short strategies, the firm is exploring them but cautioned that taxes should not drive investment decisions. They highlighted that their existing MDT market-neutral strategy already functions effectively as a tax-aware long-short solution, delivering consistent inflows and strong performance.