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Edited Transcript of FII earnings conference call or presentation 25-Oct-19 1:00pm GMT

Q3 2019 Federated Investors Inc Earnings Call

PITTSBURGH Oct 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Federated Investors Inc earnings conference call or presentation Friday, October 25, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Deborah Ann Cunningham

Federated Investors, Inc. - Executive VP, CIO of Global Liquidated Markets & Senior Portfolio Manager

* John Christopher Donahue

Federated Investors, Inc. - President, CEO & Chairman

* Raymond J. Hanley

Federated Investors, Inc. - SVP

* Saker Anwar Nusseibeh

Hermes Fund Managers Limited - CEO & Executive Board Director

* Thomas Robert Donahue

Federated Investors, Inc. - VP, Treasurer, CFO & Director

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Conference Call Participants

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* Brian Bertram Bedell

Deutsche Bank AG, Research Division - Director in Equity Research

* Daniel Thomas Fannon

Jefferies LLC, Research Division - Senior Equity Research Analyst

* Kenneth Brooks Worthington

JP Morgan Chase & Co, Research Division - MD

* Kenneth S. Lee

RBC Capital Markets, LLC, Research Division - VP of Equity Research

* Macrae Sykes

G. Research, LLC - Research Analyst

* Michael Roger Carrier

BofA Merrill Lynch, Research Division - Director

* Patrick Davitt

Autonomous Research LLP - Partner, United States Asset Managers

* Robert Andrew Lee

Keefe, Bruyette, & Woods, Inc., Research Division - MD & Analyst

* William R. Katz

Citigroup Inc, Research Division - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, good day, and thank you all for joining this Federated Investors Third Quarter 2019 Analyst Call and Webcast. (Operator Instructions) As a reminder, today's session is being recorded. And now for opening remarks and introductions, I am pleased to turn the floor to President of Federated Investors Management Company, Mr. Ray Hanley. Welcome, Ray.

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Raymond J. Hanley, Federated Investors, Inc. - SVP [2]

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Thank you, and good morning. Leading today's call will be Chris Donahue, Federated's CEO, and President; and Tom Donahue, Chief Financial Officer; and joining us for the Q&A are Saker Nusseibeh, the CEO of Hermes; 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's 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 assumes no duty to update any of these forward-looking statements. Chris?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [3]

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Thank you, Ray, and good morning all. I will briefly review Federated's business performance, and Tom will comment on our financial results.

Looking first at equities. Gross sales increased 8% from the prior quarter and 38% from Q3 of 2018. Net redemptions in Q3 were due largely to unexpected institutional account redemptions from 2 clients. One institutional client redeemed about $800 million from a European equity mandate due to a change in their equity allocation model. In addition, the BT Pension Scheme redeemed about $720 million from their equity separate account assets. These redemptions were partially offset by the addition of a new Global Emerging Markets separate account in Q3 that funded with about $766 million. Although we continue to work closely with BTPS on their planned asset allocation changes, they are a mature, corporate defined benefit scheme and their investment goals include derisking in the portfolio over a long term.

As we have discussed, Hermes has made great strides to grow its third-party business, which has accounted for 82% of year-to-date revenues. We had 15 equity funds with net sales in Q3, led by the Kaufmann Small Cap and the Global Emerging Markets funds. Several other funds achieved net sales in Q3, including Hermes' SDG Engagement Equity Fund, the Global Equity ESG fund and Impact Opportunities Fund, along with the MDT Small-Cap Growth and All Cap Core funds.

Using Morningstar data for trailing 3 years at the end of Q3, about 1/3 of our equity funds were in the top quartile and nearly 2/3 were in the top half. Now looking at the strategic value dividend strategy, its objective is to provide a high and growing dividend income stream from high-quality companies. The domestic fund's 12-month distribution yield was 3.7%, which ranked it in the second percentile in its Morningstar category at the end of the third quarter. Interestingly, the fund returned 3.2% in Q3 and 14% year-to-date through September 30.

At that point, the fund ranked in the 10th percentile of its Morningstar-assigned category for the quarter, 14th percentile for the trailing year and 96th percentile for the trailing 3 years. The domestic Strategic Value Dividend strategy had combined mutual fund and SMA outflows in the third quarter. They were about $584 million compared to outflows of $494 million in the second quarter.

Looking at early Q4 results, combined fund and SMA net redemptions for this strategy were about $25 million through the first 3 weeks of October. Overall combined equity and SMA net redemptions for the first 3 weeks of October were $274 million.

Turning now to fixed income. Assets increased to a record high of nearly $66 billion at the end of the third quarter due mainly to market-related gains of $1.5 billion partially offset by net redemptions of a little over $600 million. On the fund side, we saw net sales of Ultrashort Bond Funds, the Federated Bond Fund and high-yield funds. As discussed in our previous earnings call, Q3 fixed income fund results were impacted by the redemptions in the Total Return Bond Fund from an individual client who made a model change. These redemptions totaled approximately $600 million, while the fund as a whole showed net redemptions of $483 million.

For fixed income separate accounts, the net outflows were due largely to net redemptions from funds where we act as a subadvisor, about half, and to asset allocation changes made by an insurance company client for the other half. At the quarter-end, using Morningstar data for the trailing 3 years, we had 8 funds in the top quartile and 19 funds in the top half. Combined fixed income and SMA have net sales of approximately $265 million early in Q4.

Now we turn to money markets. These assets increased about $26 billion in Q3. We saw positive money market fund flows from a variety of institutional and intermediary clients during the third quarter. Money market strategies continue to have a significant yield advantage compared to average deposit rates. With recent Fed rate cuts, money fund yields also compare favorably to applicable direct market rates and to longer-duration securities given the relatively flat yield curve.

Our money market fund market share, including sub- advised funds at the end of the third quarter, increased to just over 8.4%, up from about 8.1% for the prior quarter and 7.3% for the third quarter of 2018. Net redemptions in the private markets and alternative space were really due mainly to a successful private equity fund, with underlying asset sales leading to cash

(technical difficulty)

We continue to raise funds in our direct lending business and are targeting another close of our European direct lending fund over the coming months.

Taking a look now at our most recent available asset totals with Federated as of October 23, Hermes as of October 18. Managed assets were approximately $536 billion, including $366 billion in liquidity, $81 billion in equity, $67 billion in fixed income, $18 billion in alternatives and $4 billion in multi-asset. Money market mutual fund assets were $267 billion. RFP and related activity levels continue to be solid and diversified, with interest in MDT, Strategic Value Dividend, Global Emerging Markets for equities and for corporates high-yield and -- I mean, for fixed-income corporates, high-yield and short duration. We began the quarter with about $100 million in net institutional mandates yet to fund.

On the international side, we've had a good response from clients for the initial funds developed for U.S. distribution that are sub- advised by Hermes. Assets in these funds were just over $60 million at the end of the third quarter, with about half of that being externally sourced. We are evaluating further U.S. mutual fund launches using Hermes' strategies, and we are actively presenting Hermes' strategies to our institutional customers and are working with Hermes to develop opportunities for them to offer Federated strategies to their clients. We are progressing on the expansion of the Hermes EOS Stewardship and Engagement business in the U.S. and are working to hire several new engagers. Hermes' EOS assets under administration reached $781 billion at the end of the third quarter, up from $638 billion at the end of the second quarter. We believe the quality, depth and breadth of Hermes' EOS capabilities is a powerful differentiator, adding important insights and information to our investment processes.

Hermes' managed assets at quarter-end were $44 billion, down from $45.7 billion at the end of the second quarter. The decrease was due to the negative impact of foreign exchange rates of approximately $1.2 billion and net redemptions of about $900 million partially offset by $377 million of market-based gains. We are looking to grow our business relationships and opportunities, both inside and outside the U.S., including through alliances and acquisitions to complement our domestic U.K., European, Asia-Pacific and Canadian operations. Tom?

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Thomas Robert Donahue, Federated Investors, Inc. - VP, Treasurer, CFO & Director [4]

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Thank you, Chris. Total revenue was up about $19 million or 6% from the prior quarter due mainly to $13.6 million of higher money market revenue primarily from higher average money market assets and $3.9 million of higher revenue from an additional day in Q3. Performance fees of $1.4 million were recorded in Q3. No performance fees were recorded in Q2. Revenue was up about $32 million or 10% compared to Q3 of last year due mainly to higher money market revenue of $37 million partially offset by a decrease of -- in revenue of $1.7 million related to lower average equity assets.

Looking at operating expenses. Comp and related increased about $5 million from the prior quarter due mainly to higher incentive compensation expense. Distribution expense increased $6.1 million due mainly to higher average money market fund assets. Other expense increased due to the onetime reversal of $1.9 million in Q2 of amortization of intangible expense related to the Hermes acquisition due primarily to the finalization of the purchase price allocation.

The increase in total operating expenses from Q3 2018 of $24.3 million was primarily due to higher distribution expense from higher average money market fund assets and to higher incentive comp and related expenses. The nonoperating income increase in Q3 is primarily due to an increase in private equity carried interests on assets managed by a Hermes-related nonconsolidated entity. The bottom line EPS impact on Federated, after reflecting the minority interests and taxes from the carried interests, was approximately $0.03 per share. We are not able to predict the timing or size of future potential carry to be earned.

At the end of Q3, cash and investments were $309 million, of which, about $259 million was available to us. We remain on track to close the PNC deal announced in May, and we expect to close it around the middle of the fourth quarter. Jim, that concludes our prepared remarks, so we'd like to open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll go first to Patrick Davitt with Autonomous Research.

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Patrick Davitt, Autonomous Research LLP - Partner, United States Asset Managers [2]

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It looks like the money market funds coming in from PNC still have about $3 billion more assets than the $9 billion you had originally guided after they rolled out the money they were keeping for their cash sweep. Do you think that's the amount that's going to move over? And if so, are there any updated thoughts on the potential accretion from those assets?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [3]

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Any potential -- what was the last part, Patrick?

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Patrick Davitt, Autonomous Research LLP - Partner, United States Asset Managers [4]

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Any updated thoughts on the potential accretion from those assets?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [5]

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Oh, okay. So we're not going to give a forecast on accretion, and the assets are public and that's what they are. We don't know what will come over when we close. We're going to merge those assets into our funds. If that's where the assets are when it merges, that's what we'll get. But things change.

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Patrick Davitt, Autonomous Research LLP - Partner, United States Asset Managers [6]

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Yes. Okay. And then you mentioned the move in other expenses. I think last quarter, you also mentioned a Hermes FX hedge. Was there an impact from that this quarter? And because of the move in the pound would that now reverse in the fourth quarter?

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Raymond J. Hanley, Federated Investors, Inc. - SVP [7]

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Patrick, it's Ray. Yes, there would've been an expense in other -- the other expense line item that was about $1.2 million for the third quarter and was more like a $1.6 million, $1.7 million for the second quarter. So -- and as for the fourth quarter, we're pretty early on, so no prediction there.

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Operator [8]

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We'll take our next question from the line of Ken Worthington at JPMorgan.

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Kenneth Brooks Worthington, JP Morgan Chase & Co, Research Division - MD [9]

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UBS is launching investment management fee-free SMAs; you're a leading SMA provider. So what do you think you would see if others sort of follow UBS? SMA fees are already pretty low. Do you think this sort of drives further pressure on SM fee -- SMA fees to accelerate?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [10]

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Ken, mentioning UBS, of course, is a great relationship with us and with Hermes. And our relationship with them has been accelerated and enhanced by the new funds that we've recently put out. And so it's not our province to comment on their pricing of their SMAs. I would note that we continue to charge on our SMAs where we have been before. And we'll have to see how this unfolds in the marketplace.

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Kenneth Brooks Worthington, JP Morgan Chase & Co, Research Division - MD [11]

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Okay. Fair enough. And then maybe second, buybacks have been more muted more recently than they've been in the past. Why is this and how should we expect buybacks to kind of evolve in the future? Any reason not to think that they return to sort of prior levels?

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Thomas Robert Donahue, Federated Investors, Inc. - VP, Treasurer, CFO & Director [12]

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Well, we have about 900,000 shares available on our existing program. We have a history of completing our programs, and we remain active in the share -- in purchasing shares, and we look at it every day with what is going on, what cash we are going to use. In the past, when we've done transactions like the Hermes deal, back in the days with Kaufmann and others, we didn't usually buy as much when we spent our cash on acquisitions. Of course, we have the PNC deal coming up, and we will continue to be active.

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Operator [13]

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Next, we'll hear from Dan Fannon at Jefferies.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [14]

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The discount brokers went to 0 commissions on the -- on stock in ETF trades and one of the large ETF providers talked about ETFs now becoming more of an equivalent for cash-like instruments. So just curious how you think about the competitive backdrop for money markets and if ETFs can be a more specific, kind of, direct competitor and as you think about that going forward based on those changes?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [15]

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It strikes us that big large customers, such as we have on the cash side, are not influenced one way or the other by a $4.95 charge whether it's there or not. The next point would be that our customers overwhelmingly are looking for daily liquidity at par, and we are simply not aware, from our customer base, of that kind of a dynamic occurring where the cash that they have with us would be susceptible to moving into a variable asset value ETF. And also note that those ETFs are priced either $100 or $50, which is really setting the stage for allowing a change from the NAV based on bid-ask spreads. And don't forget, there are trading differences in how those ETFs work, where they trade more like stocks [in] T+2, and our customers are more interested in the current use and capability of getting their money. So basically, I would say that not all pontifications apply to all clients, and we haven't seen that dynamic.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [16]

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Understood. And looking at the alternatives business and, kind of, the outlook based on, I think, you mentioned a few funds where there's demand and we've seen also the redemption side be a little bit higher here since basically you've owned these assets. So just curious as we think about, kind of, 2020 and potential fundraising or demand and -- versus the, kind of, redemption cycle, like how you think about the net growth of the broader alternatives business.

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [17]

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Saker?

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Saker Anwar Nusseibeh, Hermes Fund Managers Limited - CEO & Executive Board Director [18]

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As far as the redemptions are concerned, part of those were planned as part of our private equity business, which is when an investment is successful, there is a planned realization from the fund in fact selling the underlying investments and returning the cash to clients, and that's something we do on a regular basis and that's partly how we get paid. So that is a positive thing, not a negative thing in fact. Now I can't predict when other such outflows will happen. It depends on when the equities investment matures and so on. Part of it is one particular unit trust, which is a kind of fund structure we have in the U.K., which is a property of the trust and the redemption there largely came from U.K. defined benefit pension scheme clients looking to derisk their portfolio as they move towards an insurance buy out of their liabilities. And again, that is specific to that client. In terms of asset raises, again, it's difficult for us to predict until we can see them, and we'll have to come back and tell you when we've seen the reality. What I can say is direct lending business targeting another close -- another -- that's another one of our European direct lending fund in late Q4 2019 or early Q1 2020 and so that is on our cards.

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Operator [19]

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(Operator Instructions) We'll hear from Michael Carrier with Bank of America.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [20]

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The first -- it's another question on the alternative side. I think you guys mentioned either some revenue on the performance fee side and then also the carry in the nonop area. I know these things are tough to predict so I'm not going to ask you to do that. When and maybe this is for Saker really, when you look at the products that have, whether it's performance fees or carry, like maybe what's the magnitude or what are the assets that can throw off those fees over time? And then just separately on the direct lending side, do you have the size of the last fund that you raised on the European side? Obviously, this fund could be different, but just so we have some context around it.

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Saker Anwar Nusseibeh, Hermes Fund Managers Limited - CEO & Executive Board Director [21]

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Let's start with the carry fees. The carry fees are connected to the last answer I gave, which is that when obviously an investment is successful and you close it down and return cash to clients quite often part of the way we get paid is partially carry fee which is what you saw there. And no, I'm sorry, I cannot predict either the size or the quantum. What I will say to you is that if you look at our previous record, which is public record of our financials, you will find that on a pretty regular basis, our private equity business seems to generate for us a carry fee of a certain magnitude. What we can't determine is when it will happen. That is

(technical difficulty)

so that's on the carry fee. Performance is performance. And again, if you look back over time, you can see the magnitude has been there. I can't again, predict it'll happen again or when it will happen, but you can [see] for that. And that brings me to the final one, which is what did we close back on, what we closed the first one on and the answer is, I'll come back to you with that off-line and when I get that information. We have it, but I'm just collecting it now.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [22]

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Okay. That's helpful. And then, Debbie, maybe just on the money market fund business, obviously the flows continue to be robust. This quarter, just given some of the volatility that we saw in repo markets, just more curious what you saw in terms of like client demand or preference among products and anything that was more surprising? And has that calmed down once the Fed has stepped in?

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Deborah Ann Cunningham, Federated Investors, Inc. - Executive VP, CIO of Global Liquidated Markets & Senior Portfolio Manager [23]

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We continue to see demand across all 3 categories of our products. This includes governments, primes and munis. On an actual dollar basis, the government's probably garnered the most just given their larger size. But on a percentage basis, primes and munis actually outgrew the government sector. Having said that, we -- the shareholders in all of these products benefited from the volatility in the repo rates during the mid-September time period, and to some degree, continuing as we go into the fourth quarter, although on a much, much more muted basis. And it certainly was not reflective of any type of credit event in the marketplace. So they were pretty easy conversations to be having with our shareholders who were questioning what -- what in fact, was happening in the marketplace. What it basically came down to was a supply-and-demand mismatch with some regulatory overlay and maybe some operational glitches from the Fed themselves, at least initially, when they wanted to begin open market operations over again. So those are pretty easy stories to have or information to give to underlying shareholders, and the comfortability, I think, increased to their participation in the marketplace at that point then.

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Saker Anwar Nusseibeh, Hermes Fund Managers Limited - CEO & Executive Board Director [24]

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Just before you go, I just have checked now and the first direct lending fund closed at 80 million.

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Operator [25]

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Our next question will come from Bill Katz at Citi.

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William R. Katz, Citigroup Inc, Research Division - MD [26]

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I just want to come back to discussion of SMAs for a moment. Can you tell me of your SMA maybe it's a 100%, but how much of that is actually geared to the wirehouses? How much do you have relative to UB? And then maybe the more germane question to me is, whether your expense ratios lineup versus peers in that category?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [27]

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Well, Bill, we wouldn't talk about it -- a client balance. I would -- and I don't have the wirehouse percentage. We're in a variety of platforms there, so we're not going to have a lot of success. That might be something we can look at and come back to off-line.

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Thomas Robert Donahue, Federated Investors, Inc. - VP, Treasurer, CFO & Director [28]

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The expense ratios are roughly middle of the pack without having done an expert exact study on the subject.

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William R. Katz, Citigroup Inc, Research Division - MD [29]

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Okay. And then maybe a bigger-picture question, putting the cyclicality of the money market business to the side for a moment. On the long-only business, between what you're winning and what -- you saw the redemptions into the new quarter, just sort of step back, it seems like there's a lot of small things that are happening. Even at direct lending, it sounds like it's relatively small opportunity. At what point do you get to scale the business to drive maybe more consistent positive growth or more visible organic growth on a long-only side? Is it investment? Is it time? Is it broader distribution? Is it product? What do you think is sort of the missing piece here?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [30]

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Well, the list you made is almost comprehensive and it requires a lot of blocking and tackling. There's no one of those that you can say, "Oh! That's the answer." You must have the investment performance, you must have the distribution side, you've got to have the products right at the right time. And the way this business has worked on all of those, they don't all work in sync all the time. You don't win every game. And I don't think there is anything missing. There is just a constant effort of doing the blocking and tackling necessary to win. And that's why, for example, during this quarter, even though we had negative flows, we have 25 different mandates, 15 on the equity side, 10 on the fixed income side, that had positive flows. And if you look at the gross sales, it's a nice thing to look at, even though I know you guys are legitimately focused on net flows. On the growth side, when you are continually selling more each time, it is a voice of the marketplace saying that you are doing the right thing. Redemptions, yes. And obviously that drives the revenues and the net income. But that's another good one to look at to see if we're getting it right and that gives us a lot of confidence in the business model. One other thing I would say that makes us unique is the power of the money funds. Don't forget, when we went public in '98, and you were there, Bill, our phraseology was a franchise for all seasons. And so these money funds really count in terms of producing revenues and net income at times when other things aren't firing on all cylinders. And therefore, you can keep the other aspects of the business going very strongly and this has worked out very well for the long haul.

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Operator [31]

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Our next question comes from Brian Bedell at Deutsche Bank.

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Brian Bertram Bedell, Deutsche Bank AG, Research Division - Director in Equity Research [32]

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Maybe just switching over to Hermes on the third-party distribution effort. Just going to Slide 18 and looking at the net third party inflows. Maybe if you could just talk a little bit about the potential to get the third-party net inflows back up to sort of where they were over the past 3 years in that $4 billion-plus, and how long do you think that might take if we have, sort of, a neutral-ish view on -- as investors are sort of neutral on putting money back into work in global and EM products? And maybe talk about the product development pipeline to get you there.

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Saker Anwar Nusseibeh, Hermes Fund Managers Limited - CEO & Executive Board Director [33]

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So there's a kind of lot that's kind of just generalities. So on the specifics, I'd say the following. I'd say that this particular quarter, we had 2 very specific large outflows, which do happen every now and then, and they were more than made up in terms of revenue by one inflow that came the other way in terms of how do we predict the future. We look at our RFP pipeline, and RFP pipeline is pretty much at the higher end of what we've seen in the past, which gives us a lot of confidence that we'll continue to see this coming through. If you ask me what are we going to get it into, and I would say to you that we're seeing growth across the board. We've seen, for example, if you look at the third quarter, we saw wins in absolute credits, in global equities as well as in GEMs, and we saw 3 new clients added to our stewardship business, with a combined assets under advisement of about $10 billion. And if you look at the funds that we have been launching successfully, ranging from the high-yield global fund to the SDG funds, these continue to garner new assets as they grow and to meet demand. And it's worth highlighting that in many of these cases, we're launching them with clients who, in fact, put them on their platforms and seed them, which tells you there's a lot of demand out there for them. So I am reasonably happy that the funds that we have are attracting increasing flows from third-party clients. And I'm pretty happy that the funds that we are creating and bringing to the market in the SDG space and then the ESG space continue to find a lot of traction.

Finally, I'd say that as Chris has mentioned, at the end of the day, you buy anybody's funds because of performance because that's what the clients really want, and our performance remains very strong with -- we calculate performance because we have a combination of institutional equities -- equity-institutional money and fund money [is] slightly differently. And we'd say that to the end of the quarter, some 65% of our assets were ahead of the benchmark, which put 74% of them ahead of the median and our information ratio on a weighted basis comes at 0.59, which means that we have made real money for our clients across all our funds after fees. So I'm reasonably optimistic just given we live in a volatile market.

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Brian Bertram Bedell, Deutsche Bank AG, Research Division - Director in Equity Research [34]

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Great. No, that's good color. It's a good segue also to my second question for Chris, back to the UBS SMA. I mean, just in your experience over a very long time period, sometimes we've seen pricing moves from competitors, and rarely this is larger on active products. But I guess, Chris, in your judgment, what do you think will pan out here in terms of what clients do between performance and looking at just simply, simple discount on fees?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [35]

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Well, over the long haul, perhaps our experience in money market funds is somewhat indicative. Back in the '70s, they were differently priced than they are today and there were always efforts to lower the prices over those many decades. And our job is to continue to produce the performance, the underlying product, tell the story and maintain the efficacy of the business. And in the end, the clients are willing to pay for performance. And clients can in that sentence mean the underlying client and/or the intermediary client who absolutely wants to be able to select the best of the best for these type of efforts. I'll highlight one thing that is perhaps unique about some of the things that we do and -- with intermediaries, and that is a portfolio construction where you're adding value by looking at the underlying risks that the intermediaries are taking with owning different products and activity. So isn't exactly an SMA comment, but it is a comment on adding value in the investment process in helping people figure out the nature of the risk that they have. But I'm not really going to go further than I went in to the answer to the question in the first time about where this might -- how this might roll out into the marketplace because I'm not interested in commenting on UBS' activities, and it isn't long enough in the tooth to see where this is going to come out.

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Brian Bertram Bedell, Deutsche Bank AG, Research Division - Director in Equity Research [36]

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And do you think people are going to be -- or even the manufacturers at other platforms will be in a wait-and-see mood to see how this plays out before they do anything else on pricing or would you...

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [37]

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I just don't know. You can always assume in this business that there is always pricing pressure. It is just part of life.

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Operator [38]

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Next we'll take a question from Kenneth Lee at RBC Capital.

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Kenneth S. Lee, RBC Capital Markets, LLC, Research Division - VP of Equity Research [39]

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You touched upon seeing some outflow related to the BT Pension Scheme in the quarter. Just wondering if you had any updated thoughts on expectations for the outflow glide path for this year and maybe next year.

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [40]

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Saker?

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Saker Anwar Nusseibeh, Hermes Fund Managers Limited - CEO & Executive Board Director [41]

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Thank you. The -- our relationship with BTPS remains a very close relationship. They are a major clients of ours, and we continue to work very closely with them. If we look at their assets, the majority of the assets that we now run for them are in fact in private market assets. Now why do I say that? Because they are a maturing defined benefit scheme that according to the fashion in the U.K. or the methodology applied in the U.K. is on a derisking path. And therefore the withdrawals are within what we understood to be happening on that derisking path. It's difficult because they have their own fiduciary duty that they've got to adhere to, to how they stick to that down glide. But I would say it's pretty much as one would expect it to be at this stage.

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Kenneth S. Lee, RBC Capital Markets, LLC, Research Division - VP of Equity Research [42]

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Got you. And then one more, in terms of the -- and this one on the money market fund area, I'm wondering if you could just provide a little bit more color on the competitive dynamics between money market funds and in particular, bank products? And specifically, whether do you expect the money market fund yields to continue to lag behind bank deposit rates on the way down if short-term rates were to continue to fall?

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Deborah Ann Cunningham, Federated Investors, Inc. - Executive VP, CIO of Global Liquidated Markets & Senior Portfolio Manager [43]

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Sure. From a bank-products perspective, certainly whether you are looking at the institutional side of the market or the retail side of the market, makes a difference. But in either case, the money funds, the managed products, the full products continue to provide a pretty substantial spread versus those direct products in the marketplace, something in the order of 100 to 150 basis points on the retail side and probably still something to the order of 15 to 20, maybe even larger on the institutional side, depending upon the size of the institution. As for the lag in the marketplace in a declining rate environment, essentially what we have seen initially was a slightly inverted money market yield curve that's turned into a fairly flat money market yield curve that is now back to a positive money market yield curve, which is reflective of both expectations from the Fed's movement in the future as well as some of the supply-and-demand dynamics, especially in the treasury market. And with that more steepening of the yield curve and the ability for we as liquidity managers to be purchasing the higher end -- the higher-yielding securities out in the 6- to 12-month areas, I would expect that we'll continue to be able to maintain some of the yield in the portfolios, not necessarily entirely reflecting each move that the Fed might make. And that's basically what we've seen with that, sort of, inversion to flattening to slight steepening now that's already occurred that the 25 basis points fully don't -- haven't played out and potentially won't if that type of a yield curve configuration is maintained.

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Operator [44]

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And our next question will come from Mac Sykes at Gabelli.

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Macrae Sykes, G. Research, LLC - Research Analyst [45]

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I actually have a 2-part question so just answer it together. Would love to get your feedback. My questions are around your sense about the potential for disruption by short duration cash ETFs versus traditional money market funds? And then given your leadership and understanding of regulatory matters with managing cash assets, do you see any issues with any of the innovation on the ETF side?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [46]

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So I already commented on the potential of ETFs disrupting money market funds, which we simply don't see because customers that we deal with want daily liquidity at par. So I'm not going to go through that catalog. I would ask Debbie if she has comments on that part, and then we'll get to the second part.

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Deborah Ann Cunningham, Federated Investors, Inc. - Executive VP, CIO of Global Liquidated Markets & Senior Portfolio Manager [47]

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Well, I mean, we certainly have reviewed the competitors in the marketplace that have ETF products, and like many other types of short-term products, our Ultrashort Funds to be included, they have gathered assets in the most recent rate environment -- declining rate -- slightly declining rate environment that we've been in. However, not to the same degree that we have from a money market fund industry, and certainly, from Federated's experience with our money market funds perspective. So I think to some degree, as we go south of 2% on short-term rates, the low-rate environment, well above 0, but still lower rates, causes people to maybe want to look at their cash balances as to what buckets they need to be in. Those that are absolutely necessary for daily activity versus those that maybe -- might be drawn on 6 to 12 months from now. And potentially there you get some stratification as to how your cash is invested. But at this point, we're not even really seeing any kind of impediments from an ETF perspective in that regard.

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [48]

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I think the second part of your question related to the future of cash. And I have a lot of confidence that the Fed will protect its province on crypto currencies and wanting to run the show as they have indicated that they will do. This does not mean that we are not exploring, working on all sorts of ideas about the future of cash, which I'm not going to get into much detail on. But you can -- I can assure you that things like 7×24, Round The Globe and things like that are being investigated by many in this field. And we will be in the forefront of that as it evolves.

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Macrae Sykes, G. Research, LLC - Research Analyst [49]

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Sorry for the duplicate question, I was jumping calls.

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Operator [50]

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Our next question will come from Robert Lee at KBW.

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Robert Andrew Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD & Analyst [51]

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And I apologize that you may have mentioned this earlier, I was also did get on the call a little late but actually, my first question is on the BT Pension Scheme. I mean I know it still owns about 29%, call it 30% of Hermes, and can you just remind us what the expectation is there for them selling down their stake over time if there's kind of a preset formula or schedule where they can start putting it? And is that something that you would expect Federated to participate in or would that be more Hermes employees taking over their holdings or buying in their holdings?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [52]

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Rob, okay. The arrangement that we made with them when we purchased the 60%, and you remember the employees owned -- own and still own 10.5%, and the pension scheme own 29.5%, and they have and we have a put and call arrangement that begins in year 3, and they can put it or we can call it and there is a pricing mechanism that we would go through if either of those happens. And that's quite simply how it works. That would be Federated purchasing it, that would not be the employees purchasing it.

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Robert Andrew Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD & Analyst [53]

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And would that be like the whole chunk at once or can it actually be kind of put in like tranches over time? And I guess maybe as a corollary to that. I mean, if you look at some other firms where they have kind of maybe some type of outstanding contingent purchase possibility. You often see these mark up and markdowns through the P&L related to how they're valuating that over time -- and maybe that is in your numbers, I don't remember seeing it. Can you kind of refresh us on how you kind of account for that?

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Thomas Robert Donahue, Federated Investors, Inc. - VP, Treasurer, CFO & Director [54]

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Yes. Okay, a couple of things. As Saker has mentioned, they are a good client, and we would work with them while we have a document that has a written put and call arrangement. We would work with them and be flexible, and we have discussed with them our ability to work with them and be flexible as to what they would want to do and what we would want to do and what made sense for both of us. The valuation that we have to do on what we own is a -- it was a quarterly thing, and we have to go through and run a valuation of what -- how we value that through the accounting process and that's an ongoing thing. It's based on forecast. We have an outside adviser who gives us -- looks at our forecast and what we think is happening and gives us a value. It's then reviewed by our internal or our external auditors and shows up every quarter.

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [55]

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Rob, if I could add. Yes, we have a very specific put and call arrangement with our partner client. But in the -- at the end of the day, any transaction that occurs in that 29.5% is going to be a negotiation. And that's just the way I think about it. Yes, we have an agreement, I'm not trying to step away from the agreement, but that's the way that thing works in reality in my opinion.

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Robert Andrew Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD & Analyst [56]

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Great. And maybe a follow-up, and again, I apologize if you covered this in the early prepared remarks, but if I look at the fixed-income business, I mean your performance last time I checked seemed -- continues to be pretty competitive and fixed income broadly, for the industry has been a relatively bright spot, but certainly this quarter and maybe with the last quarter feels like it's been more of a struggle for you to kind of participate maybe as much as some of your peers. Can you maybe shed some light on that? Is it just kind of the ebbs and flows? Maybe you have a little bit higher high-yield orientation than maybe some of your peers do proportionally? Is that or the short duration kind of having some impact on the optics?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [57]

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As I mentioned, the $600 million of net redemptions for fixed income this quarter, about half of that was from funds where we act as sub-advisor, which means someone else is doing the primary work and the primary distribution. And then the other half of that, as I mentioned, was from a one insurance company client who just changed their asset allocation. So behind the curtain, we don't know exactly whether that was related to high yield or whatever it was related to by them. And we also mentioned that we're about $265 million to the good in Q4, which is only a few weeks, I grant you that. And then we tore in a little bit into Total Return Bond Fund and showed that really it was one big client move that is -- another model change that redeemed more than the total of the net redemptions, which meant that without that client, it was positive. So these are the ebbs and flows of life where people have to [wait] to get their money at any time for any reason and there's a little bit of Red Queen in all of these businesses, and we think we have a model to run twice as fast as that in order to advance the ball.

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Operator [58]

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Thank you. And thank you to our audience for posing their questions, and thank you to our leadership team for taking the time to answer the questions today. Our final question in the queue comes -- is a follow-up from Patrick Davitt.

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Patrick Davitt, Autonomous Research LLP - Partner, United States Asset Managers [59]

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Could you update us, if at all, on kind of, the APAC strategy after the comments you made last quarter? If you're still exploring partnerships and acquisitions there in conjunction with the Hermes expansion and maybe even the opportunity to get an Asian distributor to take a stake in Federated?

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John Christopher Donahue, Federated Investors, Inc. - President, CEO & Chairman [60]

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Okay. This is Chris. The Asia-Pac strategy, we turned over the efforts that we had over to the Hermes sales effort. So Harriet is running that on behalf of -- with Saker and us. And they are currently working on an expanded idea of what to do for the whole Asia-Pac region. In terms of the second part, we would always be open to, but that is a long slow slog by getting a partner who would do both a stake in Federated and a distribution effort. These things take forever. They are not catalytic in the sense that they -- that I can say what will happen or when. But it is something that we continue to remain open to. But overall, in terms of Asia-Pac, we remain very optimistic about it for the long-term future. And I'd ask Saker to comment as he sees it.

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Saker Anwar Nusseibeh, Hermes Fund Managers Limited - CEO & Executive Board Director [61]

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Thanks, Chris. So prior to Federated acquiring 60% of Hermes, we had already established an operation down in Asia, which is primarily a sales operation, although we also have manufacturing down there, both in Singapore and in Australia. And what we've done recently is we've combined our operations with what Federated was doing. So what do we see with the region, I mean you know this as well as I do, the region has an incredibly high rate of savings growth. That's the first thing. The second thing is, we know that across the board, that's to say, Federated product as well as Hermes product, these have resonance within that region so that is another tick for us. We have raised assets very successfully for Hermes from markets such as Australia, for example, both in global equities and in our future business. We've raised successfully in private equity and in public equity from markets such as Korea, and we think that there's more opportunity there for the combined company. That's on a pure sales element. Now if something comes up that we can find someone that we can partner with, obviously, we will look at that. But as you know, our partnerships in that part of the world take a long time and have to be culturally the right ones to be able to go forward with it.

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Operator [62]

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And gentlemen, at this time, there are no further questions from the audience. I will turn it back to you for any additional or closing remarks.

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Raymond J. Hanley, Federated Investors, Inc. - SVP [63]

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Well, that will conclude the call, and we thank you for joining us and for your time today.

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Operator [64]

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Ladies and gentlemen, this does conclude today's announcement, and we thank you all for your participation. You may now disconnect, and we hope that you enjoy your weekend.