FHI - Federated Hermes: Multiple Growth Drivers

2023-04-14 05:52:07 ET

Summary

• Both the investment management industry and Federated Hermes are seeing solid inflows for money market assets in early 2023.
• FHI has already identified areas of good growth potential such as ETFs where it can expand its presence via mergers & acquisitions.
• Apart from money markets, other asset classes such as equities, fixed income, and private markets are also expected to deliver decent inflows for FHI in the current year.
• My Buy rating for FHI stays unchanged, taking into consideration the multiple growth drivers for the company.

Elevator Pitch

I continue to have a Buy rating assigned to Federated Hermes, Inc.'s ( FHI ) shares.

In my earlier article for FHI written on January 28, 2023, I highlighted that investors should not be unduly concerned about Federated Hermes' below-expectations Q4 2022 reported earnings which were impacted by non-cash and non-recurring items. Since my previous update was published, Federated Hermes' stock price has gone up by more than +12% as compared to a +2% rise for the S&P 500 as per Seeking Alpha price data. This validates my view that FHI's fourth quarter headline EPS miss wasn't an issue to be overly worried about.

My current write-up will discuss about the multiple growth drivers for Federated Hermes in the short to medium term which support a Buy rating for the stock. In the short term, FHI's money markets assets should witness robust inflows, while other asset types like fixed income, equities and alternatives are expected to do reasonably well too. In the mid term, Federated Hermes' inorganic growth prospects are good, with expectations of future acquisitions in key segments of the investment industry like property and exchange traded funds or ETFs.

FHI Is A Beneficiary Of Strong Money Market Asset Inflows

As disclosed in the company's analyst presentation slides , money markets accounted for 71% of Federated Hermes' assets under management or AUM as of December 31, 2022. FHI also earned 46% of its Q4 2022 top line from money market assets, its largest revenue contributor in terms of asset type.

There are various indicators pointing to a substantial increase in money market fund inflows in the near term, which will be positive for FHI's short term growth prospects.

A recent April 10, 2023 Reuters article cited data from Refinitiv Lipper suggesting that the time period between March 30, 2023 and April 5, 2023 was the sixth straight week running that witnessed positive net inflows for money market funds. Another commentary published in media publication City A.M. dated April 11, 2023 noted that money market assets saw a +5,998% YoY growth in positive net inflows for Q1 2023 as per Hargreaves Lansdown data.

Separately, FHI mentioned at the 2023 RBC Capital Markets Global Financial Institutions Conference (event transcript sourced from S&P Capital IQ ) on March 7 that its AUM for money market assets had already increased from $476.8 billion as of end-2022 to $488 billion by February this year. Notably, Federated Hermes specifically noted at the recent RBC investor event that "we have seen some decent flows" in money markets for 2023 thus far.

Federated Hermes Is Well Positioned For Further Acquisitions

FHI has had a history of acquiring and partnering with other companies successfully and its recent deals have delivered good results. It is reasonable to assume that acquisitions will continue to be an integral part of Federated Hermes' growth strategy going forward.

Federated Hermes' Past Partnerships And Acquisitions

Federated Hermes disclosed at the recent RBC conference in early March that it had "$40 million of positive (fixed income) flows" for separately managed accounts in 2023 year-to-date derived from C.W. Henderson & Associates, a company which FHI bought over in October last year .

Separately, FHI took full control of Hermes Investment Management in August 2021 with the purchase of a 29.5% stake from BT Pension Scheme to increases its interest in Hermes Investment to 100%. At the March 7, 2023 RBC Conference, Federated Hermes emphasized that it is "seeing more and more interest in a lot of the Hermes offerings" and revealed that there was a recent $400 million mandate from Canada that Hermes is likely to secure.

Looking forward, Federated Hermes highlighted at the RBC investor event last month that expanding its presence in ETFs (Exchange Traded Funds), collective funds, and real estate will be the key consideration in the shortlisting of potential M&A candidates.

Positive Momentum For FHI's Other Asset Classes Is Expected To Be Sustained

Earlier, I touched on the significant inflows for money market assets. Federated Hermes' other asset types are also likely to do reasonably well this year judging by recent disclosures.

For the equities asset class, FHI's strategic value dividend mandate has been a good performer. Federated Hermes previously disclosed at its Q4 2022 earnings briefing in late January that the company's strategic value dividend mandate achieved sales of almost a billion dollars in the final quarter of last year. Dividend investment strategies are in favor, and this has been a tailwind for Federated Hermes' strategic value dividend mandate. FHI's strategic value dividend fund is also recently ranked in the top 10% of funds in the category it belongs to by Morningstar ( MORN ) as per the company's disclosures at the RBC Conference, which has been a positive driver of inflows into the fund.

With regards to fixed income assets, both Federated Hermes' separately managed accounts and funds have seen solid inflows. Separately managed accounts in the fixed income category for Federated Hermes saw a strong +16% YoY growth in AUM from $37.7 billion as of end-2021 to $43.6 billion as of end-2022 as indicated in its analyst presentation. On the other hand, FHI's Total Return Bond Fund recorded approximately $900 million in net inflows for this year thus far as revealed at the RBC conference.

As it relates to private equity, FHI noted at the company's most recent quarterly results call in January that it has around "$4.8 billion in net institutional mandates yet to fund." At the March 2023 RBC Conference, Federated Hermes guided that this $4.8 billion should be reflected in the company's entire AUM by end of the current year.

Concluding Thoughts

Federated Hermes' shares have outperformed the broader market in the two and half months following my previous article. In my view, there is further upside for FHI's stock justifying a Buy rating, as there are a number of growth drivers in place for the company.

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