FHI - NYSE

Greetings. Welcome to the Federated Hermes Q3 2025 Analyst Call and Webcast. [Operator Instructions] 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. Leading today's call will be Chris Donahue, CEO and President, Federated Hermes; and Tom Donahue, Chief Financial Officer; and participating in the Q&A are Saker Nusseibeh, the CEO of Federated Hermes Limited and Debbie Cunningham, our Chief Investment Officer for 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. Good morning. I will review Federated Hermes business performance. Tom will comment on the financial results. We ended the third quarter with record assets under management of $871 billion, led by gains from our money market and equity strategies. Equity assets increased by $5.7 billion or 6% from the prior quarter due mainly to market gains. Q3 equity net sales were slightly negative $130 million, as solid net fund sales of $1.4 billion were offset by about $1.5 billion of separate account net redemptions driven by one client and all their CIT strategies moving to passive ETFs. And another client where pension funds were merged and the surviving plan happens to use private strategies -- passive strategies. Interestingly, we are also seeing other clients interested in moving from passives into our MDT strategies, which have had several RFPs come in from investors considering this switch. The MDT fundamental quant strategies produced solid results again in the third quarter. MDT equity strategies had Q3 net sales of $2 billion. Looking at MDT fund performance rankings as of September 30, 7 of the 8 MDT equity mutual fund strategies are in the top performance quartile of their Morningstar categories for the trailing 1 and 3 years. And all eight are top quartile for the trailing 5 and 10 years. And four of these strategies are in the top decile for the trailing 3 years. We had net sales in 20 equity fund strategies during the third quarter including, obviously, a variety of the MDT offerings and the Asia ex-Japan fund leading the pack. We are actively developing MDT distribution opportunities outside of the U.S. and are finding considerable interest from institutions, intermediaries and others. For example, the MDT U.S. equity UCITS fund, that means it's registered for us in Dublin, launched in June, is off to a great start. We are seeing strong demand from clients outside of the U.S. and have already had $340 million in net sales from inception through last week. Now looking at our equity fund performance at the end of Q3 and using Morningstar data for trailing 3 years, 53% of our equity funds were beating peers and 33% were in the top quartile of their category. For the fourth quarter through October '24, combined equity funds and SMAs had net sales of $580 million. Now turning to fixed income. Assets increased by $3.1 billion from the prior quarter to reach a record high of $101.8 billion at the end of Q3. Fixed income total net sales improved by $4.1 billion, as we had $1.7 billion of net sales in the third quarter compared to net redemptions of $2.4 billion in the second quarter. Q3 net sales included about $1.4 billion from two large public entities that have regular sizable inflows and outflows. We had 24 fixed income funds with net sales in the third quarter, led by the three ultrashort funds with $579 billion combined, and the sustainable global investment-grade usage fund about $240 million. Regarding performance at the end of the third quarter, using Morningstar data for the trailing three years, 44% of our equity fixed income funds were beating peers and 15% were in the top quartile of their category. For Q4, through October 24, combined fixed income funds and SMAs had net redemptions of about $250 million. This was occasioned by positives in Ultrashorts and Total Return Bond Fund that were overcome by negatives in high-yield bonds. In the alternative private markets category, assets decreased by about $1.7 billion from the prior quarter, mainly due to a $1.1 billion in real estate fund transactions from -- that we have previously discussed, the restructuring of the U.K. Property Trust in the third quarter. This fund was successfully managed by us for many years. It was specifically designed for defined benefit clients. There are very few of these left. The liquidity was an important factor. The decision was made to move it to one of the last remaining managers of this type of DB fund for which we received financial consideration that Tom will address. Real estate also had net redemptions of $446 million from separate accounts in Q3 due mainly to property sales that were driven by a client's change to their asset composition. The MDT market-neutral alternative strategy had net sales of $173 million in Q3 and now stands with assets of about $1.7 billion. We are currently in the market with European Direct Lending III, the third vintage of our European direct lending fund. To date, we've closed on about $680 million. For your information, EDL raised $300 and EDL II raised about $640 million. We are also in the market with our global private equity co-investment fund which is the sixth vintage of the PEC series. To date, we've closed on approximately $318 million and PECs I through V raised approximately $400 million to $600 million in each fund. We're also in the market with the European real estate debt fund, which is a new pooled debt equity fund -- a debt fund and the marketing will continue here into 2026. We're also actively working on Energy Solutions product development plans following the Q2 acquisition of a majority interest in Rivington. Last week, we announced the agreement to purchase a controlling interest in FCP, a U.S.-based real estate investment manager with $3.8 billion of assets under management as of June 30. The acquisition will facilitate Federated Hermes' entrance into the U.S. real estate market at a time when the U.S. multifamily sector where FCP concentrates its efforts, enjoys strong fundamentals and significant growth opportunities. FCP has a strong experienced management team who have led the firm's growth through changing market conditions for over 25 years. We believe that FCP will be an excellent complement to our U.K.-based real estate business. There, with more than 40 years of experience, our U.K.-based team has more than 55 professionals managing $5.5 billion as of the end of Q3. Now back on FCP, we're planning to close the purchase around the end of the first quarter of 2026. Across our long-term investment platform, we began Q4 with about $2.1 billion in net institutional mandates yet to fund, in both funds and separate accounts. Let's delve into that. Approximately $1.6 billion is expected to come into private market strategies, which include direct lending over $800 million, private equity, a little over $650 million and trade finance at $100 million. Equities are expected additions of $1.2 billion, with about $875 million into MDT and about $365 million into international and global equity strategies. Fixed income is expected to have net redemptions of about $650 million, with wins of about $380 million in high yield and short duration offset by a single $1 billion high-yield redemption. Moving on to money markets. We reached another record high at the end of Q3 for total money market assets, which increased by $18 billion to reach $653 billion. Money market fund assets increased by $24.7 billion or 5% in Q3 to reach a record high of $492.7 billion. Money market separate accounts decreased by $6.3 billion in Q3, reflecting seasonal patterns. Market conditions remain favorable for cash as an asset class. In addition to the appeal of the relative safety and periods of volatility. Money market strategies present opportunities to earn attractive yields compared to alternatives like bank deposits, direct investments in T-bills and commercial paper. We're also developing money market funds and share classes available in tokenized form and working with parties on digital asset infrastructure. These efforts include a planned GENIUS Act compliant money market fund designed to serve as collateral for stable coins. Last week, we announced that we have made two of our UCITS money market funds, our Sterling Prime and U.S. dollar Prime available in tokenized form through Archax. Archax is a well-known digital assets operator in the U.K., having launched in 2018 and become the first FCA-regulated digital Securities Exchange broker-dealer and custodian. This represents a Federated Hermes initial non-U.S. digital asset initiatives. The Archax relationship complements our digital efforts, where we are the sub-adviser for the superstate short-duration U.S. government securities fund, a private tokenized fund with about $735 million in assets. We will also participate in the launch of a collaborative initiative between BNY and Goldman that will use blockchain technology to maintain a record of their customers' ownership of select money market funds. A significant step towards enhancing the utility and transferability of existing money market fund shares. We are exploring numerous other additional digital asset opportunities. We are committed to the digital space where we expect ongoing innovation and growth. Our estimate of money market mutual fund market share, including sub-advised funds remained at about 7.11% at the end of the third quarter. Now looking at recent asset totals as of a few days ago. Managed assets were approximately $865 billion, including $645 billion in money markets, $96 billion in equities, $102 billion in fixed income, $19 billion in alternatives, private markets, $3 billion in multi-asset. Money market mutual fund assets stood at $486 billion. Tom?

Thanks, Chris. For Q3 compared to the prior quarter, total revenue increased $44.6 million or 10%. Revenue from higher money market assets provided $17.6 million of this increase, while higher equity assets added $14.8 million. An extra day in the quarter added $4.9 million, higher performance fees added $2.4 million and the Rivington acquisition added $1.2 million. Q3 revenue also included a termination fee of $4.6 million from the restructure of the U.K. property trust, and this is about -- was about 1 year of revenue from that mandate. Total Q3 carried interest and performance fees were $3.6 million compared to $1.4 million last quarter, approximately $733,000 of the Q3 fees were offset by nearly the same amount of compensation expense. Q3 operating expenses increased by $32.2 million or 10% from the prior quarter due mainly to higher distribution expense from higher fund assets of $14.2 million. We had about $2 million in transaction costs from the FCP acquisition in Q3 in the professional service fees line. In other expense line items, FX and related expense increased by $9.4 million in Q3 compared to the prior quarter. These expenses were $3.7 million in Q3 compared to a credit of $5.7 million for Q2 as the pound weakened against the dollar in Q3. The other expense line item for Q3 also included $2.8 million related to a U.S. withholding tax matter on certain non-U.S. funds. The effective tax rate was 24.4%. The tax rate was impacted by $1.6 million related to R&D tax credits. At the end of Q3, cash and investments were $647 million. Cash investments excluding the portion attributable to noncontrolling interests were $610 million. We expect to use about $216 million in cash and about $23 million in FHI Class B stock for the upfront purchase price of FCP controlling interest acquisition. During Q3, the company paused its open market share repurchase, as we entered exclusive negotiations with FCP. We expect to be active again in Q4 and repurchase shares in the open market. Holly, we'd like to open the call up for questions now.

[Operator Instructions] Your first question for today is from Ken Worthington with JPMorgan.

This is Michael Cho, on for Ken. So my first question, I just wanted to touch on MDT franchise. I mean there's clearly some growing momentum there. You called out some new RFPs, a pretty sizable pipeline as well as some initiatives to expand distribution more notably outside the U.S. I mean, how do we think we should kind of frame the potential sizing and maybe the pace of AUM or flows growth of the overall MDT franchise as you continue to scale and as the non-U.S. distribution starts to grow. I'm just trying to get a sense of how we should frame that opportunity set.

I think you should frame it with enthusiasm and optimism. If you look at the sales to date through this time frame, they're still running net sales of -- up through October 24 of about $660 million so the pipeline continues. But for us, the exciting thing is the fact that we were able to sell these mandates across the globe. And if you look at where they're coming from, they're coming from different countries, in different ways and in different of the mandates exactly on MDT. I can't get into exactly who the clients are. But in those pipeline numbers is a great variety of client types and geographies.

Understood. And then if I could just ask a quick follow-up on expenses. Just broader over the year ahead. You have a number of initiatives. You called out a bunch today. Clearly, alternatives and the FCP acquisition is ahead, but you also have a number of things happening within money market and blockchain, digital assets and clearly, kind of extension of some of your key franchises. So I just think about the expense base and over the next 12 months or so, how should we kind of think about the trajectory there as you can continue to invest organically and inorganically across the business?

Okay. Mike, well, the first thing, FCP, we closed that near the end of the first quarter, then of course, those expenses will come in. But we've kind of factored that in -- on last week's discussion about our view of after transaction costs, it would be an accretive thing, and also in 2017, much more accretive based on our estimates of what we think is going to happen there. So of course, revenue go up and the expenses will go up. And in terms of -- you're calling out a few things. Obviously, the digital things and money market stuff and other expansions. I don't see outsized expenses coming in here. And if they do, we would fully expect them to come with revenue shortly thereafter. And if you want me to go through the -- not for the year, but for the next quarter, a few comments on the line items. I'd expect comp and related to go up, as sales are increasing and therefore, incentive comp is going up, and investment management performance is causing us to increase the incentives there. And on the corporate side, we're also increasing the incentive. These are all positive success items. On the distribution line item, we expect that to go up as you look at average assets, distribution line item and other success item goes up. On the professional service fees are looking at it today, we already said we'd expect some more FCP closing costs in Q4, but we had a couple of million, as I mentioned, in Q3, so maybe we have $3 million more as a change. And then the other line has effects in it, and that has that tax payment that we talked about and what's going to happen in FX we will see. But those are all comments on a quarterly, not a yearly basis.

Your next question for today is from Bill Katz with TD Cowen.

This is Robin Holby on for Bill Katz. Heading into 2026, what are you hearing from your institutional investors on allocations, where are you seeing opportunities? And how are you thinking about the pace of deployment for the institutional pipeline?

The institutional pipeline, I tried to hint at this a few minutes ago, is very, very strong. As we told you, we've got over $2 billion in it. And if you look into that, the pipeline is to see performance and different countries. So I was a little more general the last time, but we have a Belgium All Cap Core, MDT big mandate that we've won. In Canada, it's an international leaders mandate that we've won; in the U.K., a global equity mandate; in South Korea, a blended MDT; another U.K. client came into the All Cap Core, MDT. We have an MDT win in the Mid East as well. So it's across the board of performance-oriented activity. And then if you look at the style box security of the various MDT offerings, you get a sense that people are looking at it that way. And then I did hint that we are seeing some clients -- this is not an avalanche, don't go writing big hairy articles that people are looking at what they really own inside a passive or indexed situation and are thinking that maybe they need to look at some of the MDT mandates as alternatives.

And Robin, on the -- in terms of the pace of the funding of the pipeline, about 2/3 of it, we expect to fund here in the fourth quarter with the equity and fixed income equity inflows, fixed income outflows happening this quarter and about half of the alt funding happening this quarter. The alts usually have a longer tail, so they will continue to fund through the first half of next year, Q1 and Q2 pretty evenly.

Okay. Holly, we must go to the next question.

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

Okay. Well, thank you for joining us. That concludes our call.