Federated Investors Reports a Drop in AUM and Operating Income

Fund manager Federated Investors (FHI 0.09%) reported that net income rose 1% in the second quarter to $53.5 million, helped primarily by an increase in investment income from the company's investment portfolio.

Operating income, which excludes investment income and taxes, fell by 4%, due to a decline in fees earned on Federated's declining base of managed assets.

Federated Investors' second quarter: The raw numbers

Data source: Federated Investors.

What happened this quarter

• Average assets under management (AUM) fell by 1% compared to the prior-year period. Federated's money-market investment strategies saw average assets fall by 5%, but more profitable equity and fixed-income strategies grew by 11% and 3%, respectively, compared to the year-ago period.
• This quarter, Federated's AUM growth in equity and fixed-income products was driven primarily by market fluctuations, rather than sales activity. Notably, investor redemptions exceeded new sales by $966 million in its equity strategies during the quarter. Sales of its fixed-income strategies exceeded redemptions by a mere $14 million. While any growth is good, Federated shareholders would prefer to see growth from inflows rather than rising stock and bond prices.
• Investment advisory fee revenue fell by 7% compared to the prior-year period. The decline is partly due to a slow bleed in assets from Federated's legacy money-market strategies, and a shift in its product mix. Increasingly, investors are choosing its lower-cost separately managed accounts rather than its higher-fee fund structures. Luckily, many of Federated's expenses -- distribution payments and compensation being the largest -- are variable, and fluctuate with revenue. Notably, total revenue and expenses both declined by about 5%, compared to the prior-year period.

Image source: Getty Images.

What management had to say

In the press release, management discussed two products that attracted new inflows despite a decline in money-market strategies, the company's largest line of business. "Investors showed continued interest in the $7.3 billion Federated Total Return Bond Fund, a core holding with broad fixed income market exposure, which experienced positive net sales in the second quarter," said J. Christopher Donahue, president and chief executive officer. "Federated also saw positive flows in fixed-income funds overall, including high-yield strategies and a range of short-duration products."

Looking ahead

The asset management business can be reduced to two needle-moving factors: the amount of assets under management, and the average net fee that the manager can charge its clients.

On the conference call, Federated Investors' chief investment officer, Deborah Cunningham, indicated that the money-market industry as a whole may start to win business from banks as interest rates increase:

[W]e do think that the money funds make a whole lot more sense versus bank deposits but are kind of sticky, and they'll go up as quickly. And certainly when you look at the average deposit rates, both government and prime money market funds are above them substantially now.

This quarter, other financial institutions including SVB Financial reported winning over clients in cash management by promoting money-market investments as an alternative to lower-yielding bank deposits. As yields on securities increase faster than rates on bank deposits, Federated's money-market strategies could become comparatively more attractive to the institutions that rely on them for cash management purposes, reversing a trend of AUM losses in recent quarters.