Federated Investors: Rates Give Lift to Earnings

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A quarter-point of interest doesn't seem like much, but to Federated Investors (NYSE: FII) it's a very big deal. The company's third-quarter earnings jumped 24% over the year-ago period due to the Federal Reserve's December 2015 rate increase. A 4% sequential increase in earnings was less impressive, driven primarily by an increase in the value of securities the asset manager holds on its balance sheet.

Federated Investors' third quarter by the numbers

Data source: Company investor relations.

What happened in the third quarter

Some common themes are taking hold. Managed assets in the company's fixed-income strategies and money market funds are stagnating, while its equity funds are attracting new investors thanks to a focus on higher-yielding stocks. Here are some of the needle-moving items this quarter:

  • Managed assets in Federated Investors'equity strategies stole the show, growing 23% year over year. Rising stock prices certainly played their part, as the S&P 500 advanced about 12% on a price basis over the period.
  • The company's equity inflows are rising thanks to a chase for yield. Dividend funds made up three of its top five best-selling funds in the third quarter. Funds based on dividend-focused strategies are collecting assets under management (AUM) across the industry, whether in the form of ETFs or mutual funds -- active or passive.
  • Fixed-income AUM declined by less than 1% year over year. The company's high-yield and short-duration funds helped AUM hold up, helped again by a broader move to yield strategies. Its high-yield and short-duration funds were listed as some of its best sellers; the former offers high yield on a current basis, while the latter would benefit from future rate increases.

AUM is not created equal: Equity strategies generate more fees

Data source: Company investor relations.

  • Money market assets declined for the second quarter in a row to $248 billion, down from $255 billion at the end of the second quarter. Money market managed assets grew by less than 1% year over year.
  • The timing of the Fed's quarter-point increase in interest rates (December 2015) is still bolstering Federated Investors' earnings against its prior-year results. Fee waivers designed to keep its money market funds' post-fee returns in positive territory cost the company just $4.2 million in pre-tax earnings in the third quarter, compared with $20.3 million in the same period last year.

Looking ahead

Asset management is a highly profitable business, especially at scale. Every new dollar of AUM results in increased management fees with little or no incremental operating expenses. Most importantly, asset management is an asset-light business, which allows for the somewhat rare opportunity to reward investors with dividends and share repurchases without sacrificing growth to do it.

In its earnings release, Federated Investors announced that it would pay a special dividend in the fourth quarter by adding $1 per share to its regular dividend of $0.25 per share, for a total payout of $1.25 per share. It also received authorization to repurchase 4 million shares of stock, which gives it authority to buy back up to 4.57 million shares when combined with a previous authorization.

While the quarter-point increase in interest rates has been very good to Federated Investors, much of the benefit of increasing rates is already behind it. Meaningful growth will have to come by growing AUM (organically or by acquisition), improved efficiency in operating expenses, or both.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Federated Investors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.