Federated Hermes, Inc. (FHI) Q3 2009 Earnings Report, Transcript and Summary

Greetings and welcome to the Federated Investors Q3 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Raymond J. Hanley, President, Federated Investors Management Company.

Good morning and welcome. Today we plan some brief remarks before opening up for your questions. Leading today's call will be Chris Donahue, Federated's CEO and Tom Donahue, Chief Financial Officer. Dennis McCauley, Laurie Hensler, and Stacy Friday are here from the Corporate Finance Group, and Debbie Cunningham, our Chief Investment Officer for Money Markets will join us for questions, as well. Let me start by saying that certain statements in the presentation, including those related to investments and financial performance and asset levels will constitute forward-looking statements, which involve known and unknown risks that may cause the actual results to be materially different from future results implied by such forward-looking statements. For a discussion of risk factors, please see Federated's SEC filings. No assurance can be given as to future results and neither Federated nor any other person assumes responsibility for the accuracy and completeness of such statements in the future. With that, I will turn it over to Chris.

Good morning. I will begin by reviewing Federated's recent business performance before turning the call over to Tom to discuss our financials. Starting with the Cash Management business, money market assets decreased by $28.0 billion, or 8%, from the prior quarter with most of the decrease coming from money market funds. However, money market assets at quarter end were $30.0 billion higher compared with the third quarter of 2008. We saw elevated redemptions in September, in particular at mid-month, around the September 15 corporate tax payment date. As in Q2, more favorable market conditions for stocks and bonds likely led to lower money fund balances at Federated and across the industry. Federated also has benefitted from better market conditions, as evidenced by our solid sales of bond of equity funds and asset and revenue growth in these areas during the third quarter. Low interest rates continue to impact yields and fee waivers for money funds. Tom will provide some more information during his remarks. As we look at money market asset levels over the last several quarters, we have a different take than those lamenting the recent outflows. To us it is clear that money funds are a vital part of the financial system and offer efficient cash management services to investors through all types of market conditions. Changes in volumes are a natural part of how this business operates. During the past two years money funds generally provided an attractive haven during the worst of the market swings and credit crisis issues. In-flow levels were unprecedented and it is not unexpected that some of these assets would move around as market conditions improve. Federated has operated successfully through other high and low cycles over decades of cash management experience. We tend to look beyond event-driven peak and profit asset levels to focus on the strength of our underlying cash management service business. Federated retains its strong core client base, who depend on our money market products as an essential component of cash management services. We expect this core business to continue to grow over time, with higher highs and higher lows during particular cycles, as we have experienced over the last 30+ years in this business. As the cycle turns, we are in close contact with clients to help them as they navigate changing market conditions. Our sales personnel are emphasizing our full product line so that as customers consider asset reallocations, we are responding to the full sweep of products. Our high-quality fixed income strategies, ranging from short-duration bonds to total return, international high yields, are winning business in both funds and separate accounts. Within equities we see traction in the alternative and dividend income strategies reflecting a defensive stance even as investors begin to rethink their allocations. We have a variety of products in multiple areas that are well positioned for higher sales. Our efforts are paying off, as evidenced by share-gaining bond and equity fund sales. For bond funds, our share of industry gross sales increased from under 0.5% in 2007 and 2008 to just under 1.5% in for the first eight months of 2009. Our equity gross fund sales share has also increased in 2009 compared to 2007 and 2008. Based on strategic insight data, Federated ranks 11th in the industry for year-to-date combined fixed income and equity fund net sales and has produced an 18% annualized organic growth rate for net flows in fixed income and equity funds in 2009. Thus, we welcome improved market conditions for bonds and equities and believe that we are well positioned to capture close as investors consider reallocations from a variety of sources. Looking more specifically at equities, assets increased by about $3.0 billion, or 11%, during the third quarter. Equity fund flows were positive and increased from the prior quarter. Alternative strategy mutual funds were responsible for most of the net positive flows, with good results from both the Prudent Bear and Market Opportunity funds. The Strategic Value Dividend Oriented Fund continues to show solid flows, as does the Kaufmann Small Cap Fund. Our equity mutual fund flows continue to be positive for the first couple of weeks here in October although as usual, we caution about drawing conclusions from limited time data. Within equity separate accounts, outflows were largely due to net redemptions in our SMA products. Bond fund sales again dominated the industry in the third quarter, reflecting the balance and diversity of our company, Federated's fixed income products again showed very strong sales results, gaining share against strong industry close, as I mentioned. Gross bond fund sales increased 4% to $4.8 billion from the prior quarter's elevated level. Net bond fund sales were strong, at one point $8.0 billion for the quarter, and reached a little over $5.5 billion on a year-to-date basis. About half of our recent bond fund sales and redemptions have been in ultra-short products. Close in these products tend to have higher velocity and certain investors use them as long cash products, especially in low interest rate environments. We are working with clients who are using these products to expand their business into other areas and to position other products for potential reallocations that are made by these clients. We continue to have positive net flows in most bond fund categories, including corporate, high yields, munis, and multi-sector. Our flagship total return bond fund gross and net sales continue to increase. We saw solid net inflows in fixed income institutional assets during the quarter. In the third quarter we won a handful of mandates, some of which went into mutual funds rather than separate accounts. We have about $150.0 million yet to be funded going into the fourth quarter. Turning to investment performance and looking at the quarter end Lipper rankings for Federated's equity funds, 23% of rated assets were in the first or second quartile over the last year, 73% over three years, 86% over five years, and 78% over ten years. For bond fund assets the comparable first and second quartile percentages are 32% for one year, 67% for three years, 73% for five years, and 79% for ten years. The decrease in one-year equity assets in the top quartiles was largely due to the defensive positioning of certain funds relative to the recent large market upswing. Within the fixed income area, the decrease in one-year Lipper rankings at 9/30 reflects in large part the success we had in 2008 with the high quality of our products. Returns in 2009 so far have favored lower-quality products. Our three, five, and ten year records are strong and we are above benchmarks in most of our taxable, fixed income strategies, on a one-, three-, and five-year basis. As of October 21, our managed assets were approximately $390.0 billion, including $315.0 billion in money market, $29.0 billion in equities, and $46.0 billion in fixed income, which includes our liquidation portfolios. Money market mutual fund assets stand at about $286.0 billion. So far in October our money fund assets have ranged between $283.0 billion and $291.0 billion and the average is about $287.0 billion. Regarding distribution, our sales force produced outstanding results again in the third quarter. Building from strong growth in 2008 and the first half of 2009, the third quarter saw another step up in the pace of our fund sales results as we crossed over the $2.0 billion in average monthly sales of equity and bond funds. The third quarter pace is nearly double the monthly average achieved in 2008. Regarding acquisitions, we are close to achieving full integration of the Prudent Bear and Clover Capital acquisitions from December of 2008. We are focused on expanding distribution for these products and have had success in bringing these products to new distribution opportunities. At this point, we are not looking for acquisitions targeted to specific investment expertise, though this type of deal always remains a possibility. We continue to evaluate multiple acquisition opportunities to add further assets, including money market consolidation deals. In addition, we will consider acquisitions or partnerships outside of the United States as part of the developing strategy to expand global distribution. As always, we cannot predict the probability or timing of any potential or particular deals.

Federated's revenue decreased about 4% in Q3 from the prior quarter and from Q3 2008. Compared to the prior quarter, lower revenues from money market funds were partially offset by higher revenues from equities and fixed income. The Q3 revenue impact of money funds waivers to keep yields positive or zero, was $36.5 million, partially offset by $27.9 million in related lower marketing and distribution expenses. The impact to operating income from these waivers was $8.6 million compared to $5.6 million in Q2. Based on current market conditions and current assets, we expect the impact to Q4 and Q1 2010 operating income to be approximately $14.0 million to $15.5 million. The increase in the run rate is due mainly to further declines in yields that have recurred over the last couple of months. In terms of sensitivity, we estimate that a 10 basis point increase in yields would reduce the waiver impact by about one-third, while a 25 basis point increase in yields would reduce the impact by about two-thirds. I want to emphasize that there remains a wide spectrum of potential outcomes given the multiple variables involved, including yield levels available in the market, changes in assets within the funds, actions by the Fed and Treasury, changes in expenses of the funds, mix of customer assets, and our willingness to continue the waivers. Turning to operating expenses, we remain diligent and focused on proper expense management. Operating expenses were down substantially from the prior quarter and from Q3 2008. The draw from Q3 2008 occurred despite the impact of two acquisitions completed in Q4 2008. On the balance sheet, cash and short term investments were $87.0 million at the end of the quarter and recourse debt was $130.0 million. We repurchased about 471,000 shares in the quarter. We continue to generate strong free cash flow and expect we will continue to use cash and our revolver to fund acquisitions, dividends, share repurchases, capital expenditures, and step repayments. We would now like to open the call up for questions.

(Operator Instructions) Your first question comes from Michael Kim - Sandler O’Neill. Michael Kim - Sandler O’Neill: First, in terms of the money market funds, it sounds like some retail investors are increasingly turning to bank deposits to maybe earn some higher yields. I know it's difficult for you to kind of see exactly where some of the money is going, but do you get a sense that you're losing market share there, or are you not really impacted all that much, just given your client base?

Given the client base, as you say, it's difficult to see that exactly. I suspect there is some modest movement, because it is true that retail investors are going from some money market funds into MMDAs with higher yields. But the institutional base of our business is a cash management service that really isn't as much influenced by that. And so we just don't see it the way that others do. Not that it's not true. Michael Kim - Sandler O’Neill: And then to transition to the institutional investor base, it seems like a lot of investors have yet to make any big moves in terms of rebalancing their portfolios. Where do you think we are in that process and is it possible that we see another step up in redemptions across the industry when, in fact, that does happen?

It's very difficult to predict and it's also very difficult to predict how that will be influenced by moves by the Fed, whenever that would occur. So we would just be more or less speculating on our view of where the market is going to go. We would expect that you would continue to see redemptions, net redemptions, in these money funds at this point, but to a modest extent. And that's why I mentioned in my remarks that even though the money fund assets were down by $28.0 billion during the quarter, we are still up over $30.0 billion from the prior year. And it's just to try and give a sense of balance and long-term movement that, yes, there is movement but the long-term efficacy of the cash management business remains intact. Perhaps Debbie has a futuristic view of this, different than what I've said.

I think anything I've heard is obviously it's a cyclical business. When rates are declining and stable, for the most part we're gathering assets in the money fund industry. On the other side of the equation, when the interest rates do start to go back up again, the likelihood of a decrease in assets is what has been seen in past history. Michael Kim - Sandler O’Neill: In terms of capital management, it seems like you kind of continue to preserve liquidity, to be conservative, but it looks like the buy-backs did ramp up a bit this quarter, so just assuming a deal doesn't materialize, should we expect you to get more aggressive on repurchases at some point?

Our history has been that we have used cash and not held it on the balance sheet, and when we have deals or histories then we've used it on deals and when we haven't had deals or histories, then we've purchased shares back or paid dividends. So I think you can look to our past to predict the future. Even though you're not allowed to do that in a mutual fund.

Your next question comes from Keith Walsh – Citigroup.

Two questions. First on the deals out in the industry and you talked a little more about it this quarter than you did last, but just on the money market side. With the lower rate and outflows and regulatory overhang for some of the marginal players, do you think that's going to accelerate their exit from this business? Is that why you are talking about this issue a little bit more?

I actually have a statistic that I saw. It was presented by Brian Reed at the ICI—he's their chief economist—Monday of this week. And effectively what he was showing was a pie chart that shows the top players in the industry, one through five, six through ten, eleven through fifteen—so in five firm increments—and their percentage of market share. He showed it at year end 2000 and then he showed it at the 6/30/09. At year end 2000 the top ten players in the money fund industry, according to the ICI statistics, had about one-third of the market, so about 33% market share. At the end of June 30 it was nearly 75% by the same top ten. So I think we have already seen a lot of that consolidation, but the potential for more still exists.

On the fixed income side, you talked about this earlier, the flows are strong for everybody but you seem to be gaining a little more traction with the market share gains. What's really the driver here besides performance? Are there changes to the way that you're marketing this product? If you could just give us a little color around that.

One of things, it's surfacing in the marketplace the beauty of a long-term team. There are 85 fixed income professionals divided up about one-third portfolio managers, one-third traders, and one-third analysts. And the PMs, for example, have 21 years of experience and about 17 of those years are with Federated. So that this team has a long time together, which means that the customers know who these people are, how they think, and how they act, because we stay connected with the clients. So this is the integration at Federated of the sales and the performance in the face of the customer. So now, with all of this work having been done, when the worm turns and points toward fixed income, given the good performance and then the connection with the people and the understanding that this team has been here for so long, it is a true, additional strength.

I would just add thoughts on that that clients appreciate our performance over the full cycle. They have seen how we performed during the credit crisis, how our funds were positioned, and if you look at some of our strategies, our total return strategy in particular, you can see how that played out. And so the performance in that period certainly helped us, as does our general risk profile within fixed income. We are able to demonstrate very substantial and solid performance over the full cycle, at a lower level of risk than some of the other players.

Your next question comes from Marc Irizarry - Goldman Sachs.

A question on the fee waiver guidance. For the fourth quarter I think you said $14.0 million to $15.5 million, and that was net. Can you give us the gross part of it? What's kind of the margin, because I guess the question associated with that is that the margin on the fee waivers, it appears that the channels may be taking a little more of the fee waiver on their end than we would have thought, so maybe you can help us pick through that.

When you think about the mix, remember that we have products that are priced in a lot of different ways and so across that spectrum the percentage that goes effectively to the intermediary varies and so you have seen that kind of step up a bit and that's really a function of where the assets are, what particular funds, and how that moves around. In terms of the first part of your question on the gross, if we are at $8.6 million for the third quarter and going up to a range of $14.0 million to $15.0 million, you could apply that kind of step-up to both the revenue and the related expenses and you would be in the ballpark of where we think these waivers would be, again emphasizing based on where the yields are now and where the assets are now.

So the dollar cost is [lower] by the channel and obviously it's mixed attendance then.

Right.

And you're not anticipating much of a change in that mix?

No. It could happen but it's hard for us to predict that kind of a change.

We're just trying to put some numbers out there for people to have something to circle around. And it's not really our guidance. It's, look, if market conditions and rates are right where they are and assets stay right where they are and then a whole bunch of other things, and none of those are going to happen. But we're trying to give you something to grab onto despite the many variables.

Speaking of things that could happen, do you have an outlook on rates that you would be willing to share with us? And also you said the 25 basis point change in yield, what yield are you referring to specifically?

Let me start with a couple of things. Number one, one of the biggest impact in the third quarter that was not necessarily apparent in either the first or the second quarter, despite the fact that the Fed Fund target range of zero to .25 had been identical, was the fact that repo and the actual Fed Funds rate itself, traded much, much lower within that zero to .25 range. Somewhere down near 7 to 8 basis points to the lower teens, versus what had been more like 20 to 25 basis points in the first two quarters, and even into the first part of the third quarter. Why does occur? That occurred because a lot of the collateral in the system had been taken out by the Fed and if you look at the Fed balance sheet there is a lot of discussion about the $1.2 trillion in Treasuries, government agencies, and mortgage-backeds that sit on that balance sheet right now that the market would love to see come back into play, from a collateral perspective. Obviously the Fed has said they're contemplating doing reverse repo. If, in fact, that were the case, or when that becomes the case, that in and of itself, without anything happening from a true rate change perspective, will allow that target range to go back up and the Fed Funds effective rates be much more near where it was at the beginning of the year, in the 20 basis points to 25 basis points range. That is something, that if we do $100.0 billion of repo at any single day, on a 10 basis point level, and that in fact then changes to a 20 basis point level for that same $100.0 billion, obviously there is real money that's differentiated there. So that's the first thing to think about. The second thing has to do with ultimately our outlook for the target rate itself and what that means in the context of the yield curve. We've actually seen a few things happen over the last several weeks that give us a little bit of a positive implication that maybe the beginnings of the process are underway. With Australia raising rates, with a little bit of the Fed-speak tone changing to some degree, we've actually seen a seasoning of the money market yield curve and at least in the nine- to twelve-month sector of the curve, LIBOR rates backing up just a tad bit, which hasn't been the case, really, since the beginning part of 2009. So that's effective in the context of how we overall are managing the funds. Ultimately, though, if you are looking for when we think the Fed will actually raise rates from that current zero to .25 range, probably the only thing we are in agreement about at this point is that they won't lower it any more. And in the context of raising it, we're still in the second quarter of 2010 from a most likely scenario standpoint.

And on the 25 basis points, that's simply taking the reinvestment rates that have been in place and bumping them up by 10 or 25 basis points, to get a kind of a math answer on waivers.

Your next question comes from Robert Lee - Keefe, Bruyette & Woods. Robert Lee - Keefe, Bruyette & Woods: First, I guess a quick P&L geography kind of question. The liquidating portfolios, I mean, you had that big pocket of assets come on. Where is the revenue from that going to flow through? Is that going to flow through advisory fees or is that flowing through other income or someplace? And is there any sense you can give us of kind of the fee raised kind of similar to say the Florida mandate you got when the money funds were a little higher?

The revenue will flow advisory fees. We are providing advisory services there and that's what we've done with other mandates in that area. I think you can generally infer that fee rates—I mean we can't comment on specific rates—but fee rates on this type of mandate are lower than different types of mandates. Beyond that it's tough for us to quantify it. Robert Lee - Keefe, Bruyette & Woods: Maybe just one other question. Did I understand the redemption rate in fixed income being up because of the nature of the ultra-short product? But looking at the redemption rates in the equity book and they seem to run at reasonably high rates, and even picked up a bit. I'm just curious, maybe try to talk a little bit about what about that book of business, the things that drive a kind of a industry average redemption rate.

There are a couple of things there. The products that we have with an alternative bent, like Prudent Bear, that would not have been in our numbers before. While it had solid positive flows in the quarter, it would have related redemptions as well. And so if you are comparing back more than a couple of quarters ago, you would not have had either the sales or the redemption in that number. Market opportunity is another product with an alternative bent where we see more swings in both inflows and outflows. Beyond those two, the redemptions, the gross levels are down from where they were a couple of quarters ago, up a little bit from last quarter. I don't know that there is anything else unusual that we would point to.

Your next question comes from Craig Siegenthaler - Credit Suisse.

Just to follow-up here on Mark's question, just to get it kind of clear on the fee waiver. Fee waivers were roughly about 17 and change. Last quarter went up to about $37.0 million. This quarter, although the earnings impact went down, it went from about $6.0 million last quarter to about $3.0 this quarter. The first question, is that math roughly right? Also, you talked about why that margin, the expense offset increased, and it looks like it's about 90% of the fee waivers here. So far this far in the fourth quarter, where are we in terms of the level of revenue fee waiver you expect and the expense margin of that?

The math is not right. The fee waivers affected revenue by $36.5 million and affected the related marketing and distribution expense by about $27.9 million, so the operating income impact from the waivers was $8.6 million, so it would have been plus $3.0 million from June, but still $8.6 million. In terms of looking at it going forward, I would just go back to what I said. To get to something like a $14.0 million to $15.0 million number on operating income, that implies a certain rate of increase from $8.6 million, and if you apply that rate to both the revenue and the related expense, you will be in the ballpark. At least as close, given all the things that can vary, that would put you pretty close.

On that $36.6 million, do you think that's a good run rate here? Do you expect that to come back a little bit, do you think it will go up a little bit, or no real color on that now because there are so many moving pieces?

No, we think it's going to go up based on current assets and market conditions but so will the marketing and distribution offset. That's what we are telling you to do is essentially bump both of those up in the same neighborhood that's implied by the guidance we're giving you on the operating income impact. We can walk through it offline.

Your next question comes from Cynthia Mayer - BAS-ML.

In terms of cost control it seems like a number of items declined in the quarter. Obviously comp but also travel and promotion. I'm wondering how much further can cost control go and since sometimes you true up in the fourth quarter, do you have any thoughts on Q4 comp?

We actually think we've done an excellent job of trying to contain costs through the difficult economic cycle and are looking to try to maintain things. We, of course, continue to invest in technology and in the investment area and a few other things that we have to do. You actually notice, there are a couple of line items up even though the majority of them are down. In terms of costs, in the future—you know, I have to sign a document that says this is what we expect the incentive compensations to be each quarter and signed it this quarter, and it's where we think it will be. What will happen the rest of the fourth quarter, we hope that it goes up because that will have meant that sales went up and performance went up and overall company performance went up.

Then just a question on the Kaufmann Fund, which I know is one of your higher-fee funds. It looks like it's got five stars now but still has outflows. Do you see this just as a function of where flows are going in the industry? And do you see any movement in that and are you getting any feedback from sales on potential for that fund?

The potential for that fund, over the long haul, is to get back to where we had it before. Remember, that was a $10.0 billion fund. Remember, we purchase it and it was a little over $3.0 billion. It had been $6.0 billion. It's now back about at that level. So the long-term potential is there. The sales remain strong, even in the face of basically a net redemption profile that you pointed out. The performance, over the long haul, is still outstanding and the growth aspect of that fund and its long-term performance, we think are still going to keep it in the ballpark. Its recent performance has slipped a little but it has invented that long-term record.

I think if you remember when we bought that, when we joined forces with Kaufmann, it was a single product enterprise. We have since added both a large cap and a small cap fund, and if you look at those collectively, they have net positive flow, so some of what you're seeing, in particular in the small cap Kaufmann fund, but also the large cap, is garnering positive flow.

Your next question comes from Ken Worthington - JP Morgan.

In the last cycle, and I guess this cycle, Federated is doing a very good job of winning sales into the short-term bond funds. Rates got low last time, investors were looking for yield, and again the same thing is happening today. So maybe it was less successful migrating from the fixed inc to the equity funds when that shift took place. And I think then the bond funds got killed as that transition happened into equities for the industry. Assuming that's the next step for the industry, this migration from fixed income back to equities, how will things be, or maybe why will things be different this time for Federated? Performance is better, are there other things that you're doing to capture more of those sales as they transition into equities in a maybe bigger way this cycle?

Don't forget that in the fourth quarter of 2008 we concluded to the purchase of two equity deals through Bear, which is not exactly on line with the spirit of the question you are asking, but also Clover. And one of the reasons why our numbers limped a little in the past was that our ability to play ball on the value equity side was somewhat dampened, and now with this Clover purchase we think we are in excellent position, across that group and others, to be able to play ball. Their performance has been outstanding and so we think that is a primary ingredient of why we think we will do better this time. The next point would be that in the time frame of the late '90s, when we had product that was highly rated, we were able to gain market share on sales, net sales, and assets, and so this sales force and this effort has proven its ability that if it has those products that it will be able to accomplish that. And that's why we mentioned that those are the kinds of things that we are accomplishing right now, although it's on a slightly dampened basis and so we would look forward that if the market changes and if people do go for more risk assets, that we would be ready, willing, and able, and participate in it the way you have described.

And one more comment to Chris' comment, we are seeing the equity funds at a slight positive level, right now, and the industry is not, so there is an early indicator that what he is saying is going to happen as we expect.

Your next question comes from Roger Freeman – Barclays Capital. Roger Freeman – Barclays Capital: Just to follow on Ken's question, how proactive are you, or can you be, given your more recently oriented customer base in the money market business, to get out ahead of this and propose alternative longer-dated investments, equity products, as opposed to just sort of letting those close out the door?

I will give you two responses to that. The first is that the ultra-short is a giant linking verb in this whole connection because people are moving out the curve and it gives them a little more yield, and yet sets them up for our sales force to talk about alternative product. However, don't forget that our principle client is 5,300 institutions that are offering asset allocation and investment advice services to their underlying clients, and so for us it is repeating the solid stories on a constant basis. There is no magic bullet; there is no silver catalyst. It isn't like that. It is the constant pattering of "a" blocking "d" that gets you to where you want to be in this business.

A question on compensation, I know you don't pay out this way but the account to revenue ratio increases sequentially. Presumably that is because of better performance in the credit and the equity fund. How much compensation for those folks is tied to performance, specifically?

The investment incentive comp is heavily weighted towards performance measured against peers, and to a lesser extent, benchmarks. It varies across groups, but something in the 70% to 80% range is a good estimate of how much of the incentive comp is tied to investment performance.

That will get reset quarterly based on . . .?

This is a constant exercise and our performance has been pretty solid over multiple quarters so I would not attribute the change in the ratio that you mentioned to any particular change in that particular set of underlying programs. As you point out, it's not really something we manage to, it's really a number that falls out when we add up all of the plans and take it back to revenue.

I'm just wondering, as performance improves, on a particular and relative basis, and compensation comes up to reflect that, but yet maybe the flows that would ultimately come from that that improve performance haven't really started to come through yet, do you see any sort of negative degradation in margins? Is there a timing issue to think about there?

First of all, the bonus programs have components of long-term performance and so to move it, it takes movement to move it, and would we have a situation where our performance is great and the sales force hasn't started to sell the product yet and that's going to hurt our margins, we haven't really faced that because of the dynamic and basically diversified business model that we've had it hasn't come to be a problem here.

How do you think about the marginal profitability of, or profit impact, of a dollar coming out of, say money markets versus a dollar going into equities or fixed income, taking into account the commissions paid to bring those dollars into other asset classes? And then the scale loss on the money market?

We don't really think about it that way, although to answer your question, I think the spirit of your question in a different way. You see, our margin went up and what happened, we lost money market assets and we gained equity and fixed income assets and our margin went up.

Your operating margin?

Yes.

But part of that is your cost reduction efforts on the fixed side. I'm more interested from a variable standpoint.

The thing you could look at, really the revenue comparison rate. We don't measure profitability at the asset class level. We don't have the data to do that. If you take funds and look at revenue you would have maybe a three-to-one, two-to-three-to one advisory fee rate between the average for bond funds and the average for money funds and if you go to equities, depending on the product, you are more in the six or seven range, so self-evidence that growth in the equity and bond funds, you don't need dollar-for-dollar growth to offset decreases on the money fund.

Any update for the capital requirement? What do you think the chances are of a liquidity bank versus individual capital requirements?

As we have said before, we don't think, nor would we predict, that there will be a capital requirement or reserve requirement placed on the money funds or on the investment advisors. The efforts on the liquidity bank, we're just not in a position to comment on other than to say that we are aware that people are working on it.

Your next question comes from William Katz - Buckingham Research Group.

Deb, I'm just curious, maybe you could weigh in on this one, in your comments about the longer end of the one-year curve moving more favorably, yet you still took the fee waiver guidance up a little bit so I'm curious as what other dynamics might be going on. Is it mix here, or anything else I need to think through?

It's more the contemplation that as the back-end starts to steepen out a little bit and there is a little bit more relative value in that sector, generally speaking we are contemplating getting closer to when actual rate moves occur and the zero to .25 becomes 50 or 75 or 100, in which case generally our response to those potential changes is to reduce our weighted average maturities within those products, so even though the longer end is getting more attractive we are, for the most part, taking less of that and more of a variable rate type product just to be able to reflect more quickly what we would anticipate as rising rates sooner rather than in later in those instances.

What you are seeing really is just the math of the existing portfolios that even as the process unwinds, as Debbie talks about, the assets are in the funds now. They are at lower yields than they were before and so you are going to get more of that in Q4 than you got in Q3. What happens in 2010 is very much an open question.

A number of your peers who have reported to date have sort of signaled that investments pending into 2010 is going to accelerate after a couple of years of underinvestment, given what's happened in the assets. I know you have been relatively protected, given your defensive [inaudible] in the money market business. That being said, can you talk a little about your investment needs in 2010?

First of all, I don't think we've underinvested at all. I think we have had the benefit through 2007 and 2008 to maintain our staff and get people that we needed to and also do it while we're managing the expenses properly. In terms of comps going up, our comp programs are what they are and we expect them to go up because we expect performance to improve.

So I shouldn't use the word underinvested, just less of a cut relative to your peers, I guess. Third question, Chris I wonder if you could weigh in a little bit. Yesterday I think you were on CNBC and then again this morning you sort of said it that it seems like you are a little more receptive to a deal outside the United States. I'm just sort of curious if you could maybe expand on that a little bit, what type of capability you are looking for. Is it product distribution? And then secondarily, I was wondering if you could talk about how you might finance such a transaction.

On the finance it depends on what the deal would be, of course, and so it's really tough to figure out what that would be when we're only opening the door to the concept, so getting way down to the financing of it, it's just not going to be a fruitful discussion. We believe that we have the ability and the wherewithal to finance any deals that we would do and we are disciplined enough in doing the deals, that we have a lot of confidence in that. In terms of where we would go and what we would do, I will give more of a message than a direct answer. Gordie [Tericino], who is the CEO of one of our acquisition candidates, has been putting together, with a team from Federated, some ideas as where we might go and what we might do and I suspect it will be a combination of some organic growth—we do have good business in Germany, good partners there. We have had efforts in London as well, but we are trying to take a brainstorm at looking across the globe in order to enhance some distribution internationally, so I'm not at this point able to tell you even which jurisdictions or things or areas we would be looking at. In terms of how, though—your question asked some of that—we would tend not to do the oh, here is tons of money, let's put it in and get our name up and go direct. That would not be what you would expect. What you would expect would be a partnership kind of a thing, not unlike our LVM deal, where in that deal we're working on their family of funds, they've got some distribution, we're managing some money for them. That kind of arrangement is more attuned to the culture that we have here that we think could work for the long haul. So that is the kind of thing that we would be looking at.

Your next question comes from Mike Carrier - Deutsche Bank.

Just a quick question on the mix shift. Historically, when the money markets start to bleed out and the equity and fixed income products make up a bigger portion of the pie, just given the fee rate differential, you know you get the positive fee rate shift, and in the current environment that is being offset by the fee waivers, but when you think about where interest rates are and the duration of the money market products, you gave the guidance for the fourth quarter/one quarter on the net fee waivers, but when you start looking beyond that, if rates stay unchanged, should the full impact—you would kind of be at the full impact so if you continue to see more of a mix shift you get some of the benefit on the fee rate?

My comments where for $14.0 million to $15.5 million for the fourth quarter and for the first quarter. If you start going out beyond that and say the rates aren't going to change, I don't see much different.

That's what I was getting at, meaning if most of the portfolio has turnover and if the rates remain unchanged then there shouldn't be any significant increases.

Right.

On the expenses, obviously they have come down a lot. We can back out what the shared fee waiver is from the distributors. I understand the synergies with the acquisition, but was there anything that was unusually low, just so when we look forward we're not going to underestimate some of the costs?

We did a pretty, even though they're not big numbers, pretty significant thing in travel and related and in advertising and promotion. Like I say, they're not big dollars and could those pump back up a little bit in the fourth quarter? I don't think there's any big chance there, though.

Your next question is a follow-up from Marc Irizarry - Goldman Sachs.

I think historically you gave money market fund AUM by type, by breaking it down by government, by prime assets. Can you give us an update of where you are in AUM by type of funds, and also by channel?

It was about $42.0 billion in Treasury, $102.0 billion in government agency, $104.0 billion in prime, and $40.0 billion in munis. If you want to know how they moved around during the third quarter, the Treasury funds were down about 10, the agencies were down about 12, prime was down about 4, and munis were up about 2.

In terms of the separate accounts, the money market AUM that you break out in separate accounts, is that predominantly institutional? It looks like the assets there declined more than the mutual funds, so does that therefore indicate that you're seeing acceleration in outflows from institutions?

I wouldn't make that jump. That number, for us, has always been essentially a couple of large state pool mandates where we manage money in Texas and in Florida and there has been a regular pattern of seasonality there related to the underlying tax collection rates, such that we have typically seen those assets go up at the end of the year and in the first quarter when the states are collecting taxes and then that gets drawn a bit over Q2 and Q3, so that's regular and specific state-tax-related seasonality and not a broader institutional comment.

Your last question is a follow-up from Cynthia Mayer - BAS-ML.

Just a couple of quick follow-up. I think in normal years, and I know this is not a normal year, but I think in normal years, Q4 is typically a pretty good quarter for money market inflows from corporate clients and I'm wondering if you expect any of that seasonality to somewhat offset the ongoing outflows. Second, I just noticed that the equity and the fixed income separate account flows were better this quarter. Which managers would that be and what accounts for that?

On the money funds, I think you are right, it would be hard to predict. We have observed over many years a lot of money coming in close to year end but I would be hesitant to overlay that to this year. And on the equity and fixed income separate accounts, some of that was funding, on the fixed income side, of mandates that we won before and timing of when they get funded. We did win some new ones that aren't funded yet. The other thing I would point to there is our SMA business within fixed income. That has been bubbling around. It's up to a couple of hundred million and it had been kind of a de novo business for us. So we are seeing some traction on the SMA side for fixed income.

There are no further questions in the queue.

Thank you. That concludes our call. Thank you for joining us today.

This concludes today’s conference call.