Federated Investors Is Riding the Wave of Higher Rates

By Jordan Wathen Markets Fool.com

Image source: Getty Images.

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Federated Investors (NYSE: FII) released 2016 4Q earnings after market close on January 26, 2016. The company reported that net income grew 17% year over year to $55.8 million in the fourth quarter. The leap in income was primarily due to reduced fee waivers, which were reversed as rising interest rates led to higher returns for money market funds.

Federated Investors' quarter by the numbers

Metric

Q4 2016

Q4 2015

Year-Over-Year Growth

Assets under management

$365.9 billion

$361.1 billion

1.3%

Net income

$55.8 million

$47.6 million

17%

Earnings per share

$0.52

$0.46

13%

Data source: Federated Investors investor relations.

What happened in the fourth quarter

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  • Assets flowed out of Federated Investors in its higher-fee strategies. The company reported that equity products shed about $1 billion of AUM due to redemptions exceeding sales, while its fixed-income strategies added about $300 million in net AUM from sales in excess of redemptions. In general, equity strategies carry higher fees as a percentage of assets than fixed-income strategies.

  • Average money market assets fell to $244 billion, down from $250 billion in the sequential quarter and $248 billion in the year-ago period. By their nature, money fund flows tend to rise and fall as customers use them as cash "storage."

Strategy

Equity

Fixed Income

Money Market

Average AUM

$62.6 billion

$51.5 billion

$244.2 billion

Data source: Federated Investors investor relations.

  • A general shift in mix is happening across its strategies. Its funds have generally bled assets while separately managed accounts have added assets from new and existing investors. As discussed on the conference call, separately managed accounts typically generate about half as much fee revenue as its funds but better fit new Department of Labor rules on what investments financial advisors can recommend to their clients.

What management had to say and looking ahead

According to President and CEO J. Christopher Donahue, "Federated more than doubled net equity sales in 2016 from 2015, with our Strategic Value Dividend strategies leading the way." He added that "On the fixed-income side, we saw fourth-quarter flows into products suited to a moderately rising-rate environment, including our ultrashort strategies, as well as our high-yield and floating-rate funds."

Management indicated that a change in a customer relationship will continue to weigh on earnings in the near term. It estimated that the change would reduce pre-tax income by about $1 million in the first quarter of 2017 and $2 million thereafter based on the company's fourth-quarter earnings.

The immediate benefit of rising interest rates is largely in the rearview mirror. Fee waivers on its funds reduced pre-tax earnings by $3.4 million this quarter compared to $16.4 million a year ago, which suggests the direct benefits of rising rates have mostly played out over the past year.

With the easy money behind it, attention is turning to Federated Investors' ability to grow organically by attracting assets to its funds and separately managed accounts. Earlier this year, the company capitalized on investors' demand for yield in its equity funds, and with interest rates generally expected to rise, the question is whether the company can continue to stay on its customers' radars with strategies that outperform in rising-rate environments.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Federated Investors. The Motley Fool has a disclosure policy.