Federated Hermes Inc (FHI) 2015 Q3 法說會逐字稿

Greetings, and welcome to the Federated Investors third-quarter 2015 analyst call and webcast.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Ray Hanley, President, Federated Investors Management Company. Thank you, you may begin.

Good morning and welcome. Leading today's call will Chris Donahue, Federated's CEO and President; and Tom Donahue, Chief Financial Officer; and joining us for the Q&A is Debbie Cunningham, Chief Investment Officer for Money Markets.

During today's call, we may make forward-looking statements, and we want to note that Federated's actual results may be materially different than the results implied by such statements. We invite you to review the risk disclosures in our SEC filings. No assurance can be given as to future results and Federated assumes no duty to update any of these forward-looking statements. Chris?

Thank you, Ray, and good morning. I will briefly review Federated's business performance, and then Tom will comment on our financial results. I'll begin by reviewing our equity business.

Third-quarter equity market conditions were quite challenging, as the S&P was down over 6%, and the industry experienced net outflows in equity mutual funds. Federated's equity fund product breadth and strength allowed us to produce another quarter of solid net inflows. In fact, Federated has produced net positive equity flows for eight consecutive quarters.

Total Q3 equity net sales for funds and separate accounts combined were $527 million. Federated's equity fund organic growth rate of 4.7% for Q3 annualized was again among the best in the industry. Based on Strategic Insight's data, our third-quarter equity fund net flows ranked in the top 3% of the industry. That puts us 20th out of 757 companies.

Our equity business continues to be very well-positioned with a variety of strategies producing solid performance and sales results. Using MorningStar data for ranked funds as of quarter end, six Federated funds, or 23%, were in the top decile for the trailing three years. We had 13 funds where 50% in the top quartile and about 3/4 in the top half for the trailing three years.

Performance highlights include Kaufmann large cap fund in the top decile for the trailing three and five years, and the International Leaders Fund, which is a foreign large-cap blend strategy, in the top 5% or better, for the trailing 3, 5, and 10 years. Four of our [MDT] strategies were top decile for the trailing three years, including the MDT Stock Large-Cap Value Fund and the MDT All Cap Core Fund. Our Absolute Return fund has developed a top quartile one- and three-year record in the market-neutral alternative category. And the Global Allocation Fund gives us another solid, solutions-oriented strategy with its top quartile one-, three-, and five-year record.

These performance results highlight the breadth and strength of our equity product line and position us for growth in multiple equity strategies. In the third quarter, more than half of our actively managed equity fund strategies had net positive sales led by Kaufmann Large Cap, international Leaders, Kaufmann Small Cap, Prudent Bear, MDT Stock, Absolute Return, Global Allocation, and Managed Volatility II funds. Equity separate account net sales were driven by two large EFA wins that funded for about $350 million, partially offset by net outflows in sub-advised and SMA strategies. Equity fund net sales are positive early in the fourth quarter, about $38 million through 10/16.

Now turning to fixed income, total net outflows of $594 million resulted from net negative fund flows of $896 million, partially offset by positive flows in separate accounts, $302 million. More than half of the fund net outflows came from ultrashort bond funds, which at times are used as cash management vehicles for tax payments and other purposes. However, the ultrashort funds specifically, and fixed income funds overall, are slightly net positive early in the fourth quarter.

During the third quarter, we saw net inflows in the Capital Preservation Fund, our Sterling Cash Plus Fund, and Floating Rate Strategic Income Fund, among others. High yield and total return bond were negative; however, high yield has returned to positive flows here early in the fourth quarter. At quarter end, we had nine fixed income strategies with top quartile three-year records, including strategies for high yield, government, mortgage, and munis.

Now looking at money markets, assets increased about $5 billion from the prior quarter. Money market share, money market fund share at quarter end was just over 8%. Money market mutual fund assets increased by about $7.5 billion, including approximately $3.7 billion transitioned from the Reich & Tang asset management transaction.

In our cash separate account business, we added the West Virginia local government investment pool, which funded at about $1 billion during the third quarter. We continued the substantial effort necessary to adjust our product offerings well in advance of the October 2016 requirement for floating NAVs for institutional, prime, and muni funds. We are working to have products in place to address the cash management needs of all our money market clients.

We expect to offer prime and muni money market funds that meet the new requirements, as well as government money funds, separate accounts, and offshore money funds. We continue to work on a privately placed funds for qualified institutional investors who are either unable or unwilling to use money funds as modified by the new rules. In addition to the Reich & Tang transfers, we announced an agreement with Huntington to transition $1.1 billion in money market assets in the fourth quarter. Interest levels and discussions around money market consolidation remain elevated.

Taking a look now at our most recent asset totals, as of October 21, managed assets were approximately $355 billion, including $249 billion in money markets, $54 billion in equities, $52 billion in fixed income. Money market mutual fund assets were $219 billion, and the October average for money market fund assets is about $218 billion.

Looking at distribution, solid results from each of our sales divisions drove the successful Q3 equity fund sales results. In the SMA business, net sales were slightly negative and have moved back to positive in the early part of the fourth quarter. Total SMA assets ended the quarter at $16 billion, with most of this in equities. Assets here are up about 7% year over year, and are up 75% over the past three years. Federated ranked seventh in the Cerulli Associates ranking of the largest SMA managers at the end of the second quarter, which is the most recent data available.

I mentioned two significant EFA separate account wins funded in the third quarter for $350 million. We are just starting to win business in this large category and are optimistic about this area where we have a solid, long-term performance record. Fixed income separate accounts had over $300 million in net sales in the third quarter, and we have $30 million yet to fund in the fourth quarter. RFP activity remains solid and diversified, with interest in EFA, value, dividend, and growth strategies for equities, and high yield and short duration for fixed income. Our equity RFP activity is up about 56% year over year.

On the international side, we are planning to register a Canadian domicile strategic value dividend fund product before year end, with the sales efforts to commence in the first quarter of 2016. We are looking to accelerate the good growth we have seen in Canada in our SMA business and the recent EFA institutional wins. Assets in Canada are up from $633 billion at the end of 2012, a little over $1 billion at the end of 2013, and now stand at over $1.5 billion.

We have had success in Europe with the rollout of a sub-advised high yield product with a large private bank. Assets here have grown to $250 million over a couple of quarters. The product was recently launched in Asia and the mid-East, as our September road show went to Hong Kong, Singapore, and Dubai.

We also added a EUR200 million fixed income separate account in Germany in Q3, and are looking for additional institutional wins. We continue to seek alliances and acquisitions to advance our business in Europe and the Asia PAC region, as well as in the US and the rest of the Americas.

Tom?

Thank you, Chris. Revenue was up 8% compared to Q3 of last year, due mainly to lower money fund yield-related fee waivers and higher equity managed assets. Revenue increased 3% from the prior quarter, due mainly to higher money fund assets, including assets from the Reich & Tang acquisition and additional day in the quarter. Equities contributed 46% of Q3 revenues, again, the highest percentage among the various asset classes. Combined equity and fixed income revenues were 67% of the totals.

Operating expenses increased 3% compared to Q3 of last year, due mainly to higher money market fund distribution expense as a result of a lower waivers. Operating expenses increased slightly from the prior quarter, due mainly to higher distribution expense as a result of higher money fund assets and an additional day in the quarter. The pretax impact of money fund yield related fee waivers of $20.3 million was down from the prior quarter and Q3 of last year. The decreases were due mainly to higher fund gross yields. Based on current asset and yields, the impact of these waivers to pretax income in Q4 is expected to be about the same as it was in Q3.

Looking forward, we estimate that gaining 10 basis points in gross yields from beginning Q3 levels would likely reduce the impact of yield waivers by about 45%, and a 25-basis-point increase would reduce the impact by about 65%. We expect to capture about two-thirds of the pretax income related to the remaining money fund yield waivers. Multiple factors affect the yield-related waiver levels and the ability to capture related income going forward. These factors include changes in customer relationships, fund asset levels, available yields for investments, actions by regulators, changes in the expense level of the funds, changes in the mix of customer assets, changes in product structure, changes in distribution fee arrangements with third parties, Federated's willingness to continue to fee waiver and changes in the extent to which the impact of the waivers is shared by third parties. We expect these factors and their impact to vary.

The Q3 effective tax rate was approximately 37%. Year to date, the tax rate is about 38%, and that continues to be our expectation going forward. Looking at the balance sheet, cash and investments totaled $322 million at quarter end, of which $309 million is available to us.

We would now like to open the call up for questions.

(Operator Instructions)

Bill Katz with Citigroup.

Okay, thank you. Good morning, appreciate the opportunity.

Tom, perhaps what you ended on with the fee waivers. If I heard you correctly, you're guiding to recapturing two-thirds as rates normalize. I think that's down from three-quarters of the last guidance. Can you talk about maybe what the delta might be? And then stepping back, a number of your competitors, both in traditional asset managed base and elsewhere, have been talking about possibly delaying or not going after the fee waivers from a competitive perspective. So how do we think about the other two-thirds at this point?

When you say capture the remaining, so there's no concept of capturing from the past. It's all the future that we are talking about, just making sure we all realize that. In terms of moving from 75% to two-thirds of what we'd recapture, that's the -- basically the product or the client relationships that isn't finalized. And when it gets finalized, that's when it will -- that's why it's moved down. So as we are recapturing things now, it's not affecting us.

Probably from a big-picture perspective; I'm not sure I understand that. How about from a big-picture perspective, just the thought of perhaps limiting the recovery of the go-forward fee waiver, just from a competitive perspective, potentially take some market share? It seems like some of your peers might be looking to use price as a weapon to take some volume

Bill, this is Chris.

The overall perspective there would go as follows. As Tom said, the concept of recapturing old fees waived is a non-concept, both because of the structure of an investment company and because of the existence of a free and open and competitive marketplace. So then, yes, we have seen it ever the case that people have an inclination to want to use pricing to try and capture share. And this is not our idea at all. What you are seeing that has dwarfed that concept is that the old estimates used to be that the $500 billion moved from prime institutional into govey, now you're seeing estimates in the $1 trillion range, which would put it at two-thirds of the total. And this per force, because of the pricing of government funds, will have an impact there. But we are not going to be using these as weapons or strategies in order to gain share by reducing price or not allowing the price to go back where it would have gone if they ever decide to raise rates.

Okay, just a follow-up question on money markets, just coming back to some of these anticipated changes for next year. What's your sense from the client base in terms of which way they might be leaning? Obviously, there's a lot of different selections for them. And then how do the economics of those products compare to the legacy businesses?

Well, in terms of discussion with clients about how they're leaning, they're leaning every which way, and some of them have not yet jumped on the bandwagon of figuring out what to do. Others of them have decided that they definitely want a stable NAV at any cost, at any situation. Because as you have heard me say on these calls before, a lot of these money fund clients are looking for a cash management service, which implies dollar in, dollar out, and that would tend to push them into government funds. We are seeing viability for other types of products, private funds, perhaps even the 60-day funds. Because after the first consideration of stable NAV, the yield does become a important second consideration.

We have seen with clients who sweep that they either don't want to mess around with a floating NAV or they don't want to change their systems in order to do a sweep. And so, those clients are not going to be utilizing the old standard products, and they're going to be heading primarily towards retail products wherever they can, as opposed to the institutional.

Now in terms of how this all lines up, we don't think there's going to be a whole lot of difference between what's here and what was in the legacy business. The recapture rate that we are mentioning is an issue with the client in terms of what that deal is. But beyond that, when we are looking at developing the private fund and the pricing thereof, we are looking at the standard type pricing that we have now. This is not to say that we can't and won't be in a position to respond if others decide to go another way, but that's currently how we're looking at it.

Okay, thank you.

Michael Kim, Sandler O'Neill & Partners.

Hey, guys, good morning. First, just curious to maybe get your thoughts on the recent announcement of the upcoming retirement, the Head of the Strategic Value Dividend team, particularly as it relates to potential impact to volumes or flows across the mutual funds, managed accounts, and institutional separate accounts, just given the pending transition

Yes, this is Chris. Walter Bean has had an exceptional career and part of that exceptional career just isn't the development of the record and the assets and the flows, but also the people that work with him. And so the team of Dan Peris and Debbie are an outstanding team. And as you may recall, Dan Peris has published two books over the last several years, putting the academic and scientific aspects of their investment strategy into print.

And so far, this is something that we obviously plan for, because age does not wait for anyone and we allow graduations here. And this is what Walter Bean is availing himself of. And so we have not yet seen any change in the flow of assets, nor in the interest in the product. And as I mentioned during my remarks, we are expanding the capacity of this particular strategy up into the Canadian marketplace, with full anticipation that we will be able to continue to grow that franchise. So we are very thankful of Walter's participation, wish him well in his retirement, and intend to roast him at his departure moment.

Fair enough. Then maybe one or two for Tom, any commentary on the outlook for expenses, more broadly, just given the ongoing market volatility? And then any specifics in terms of the comp line as we look into the fourth quarter and beyond?

In terms of the waivers, we've already given our commentary on that, in terms of other expenses, we've still been pretty active on continuing to manage expenses. You saw the margin tick up. While we are not declaring victory there, we were happy with that. In terms of comp, for Q4, if we do our projections, I would say it would be around 72. Of course, that has although provisos, just like the waivers does, things can change.

Understood. Okay, and then just lastly, one of the key themes that we've seen across the firms that have reported thus far has been a considerable step up in share repurchase activity last quarter. So I know you guys take a bit of a more balanced capital managed approach and the total payout ratio remains high, but just wondering if your thinking has shifted at all as it relates to maybe putting a bit more of an emphasis on buybacks prospectively.

You saw we did purchase over 500,000 shares and up from 300,000 previous quarters, and I wouldn't be surprised if that would continue. We looked at how much -- a number of different factors we go through. We have our models and start off with is it a good investment and what are the risks and balances and so we remained active all the way through.

And in terms of how much you're buying, the factor of how much shares we are issuing, we don't like the share count to go up. So that's a constant battle of having to buy shares to make sure that doesn't happen. And we were happy to be able to move up to the 500,000 level and actually nick a little bit of the share count growth. But we do run the models saying, is this a good investment, and that's our fundamental thought process.

Okay, great. Thank you for taking my questions

Ken Worthington, JPMorgan.

Hi, good morning. First, on fee waivers, the impact on Federated revenue improved slightly; that's completely intuitive. But the cost of distribution went up in the other direction, which is unintuitive. So how does that happen in the first place to have distribution actually get hurt when Federated sees a benefit? And is it just one time? I assume we won't see that again, but what is the outlook there?

Ken, it's Ray. I think what you're seeing there is a lot of it is the impact of bringing in the new assets through the Reich & Tang acquisition. There would've been a -- they would've had their own characteristics in terms of revenue and distribution expense. If you look at it overall, the waivers, the pretax impact, the impact of Federated was about 24% of the revenue that we waved. And so, that was down sequentially and down year over year. So that -- the portion that has affected us has actually gotten better, but specifically on the line items you're talking about, I think you're getting some acquisition impact for this particular quarter.

Okay, I should have figure that out. Thank you there.

And then maybe higher level, performance is -- fund performance, product performance is good. Compensation flat to down, non-distribution cost flat, yet you've been investing in certain areas of the business. What levers are you pulling to manage compensation and manage other expenses while you're investing in certain parts of the business? And then when you see higher rates, there's going to be a revenue windfall. Are there projects that have been pushed back in the lower rate environment than you would expect to be pursued when you get the inevitable revenue windfall? Thank you.

First of all, let me comment on the choice of vocabulary. Not to quibble, but when the revenue from our money funds is restored, we don't consider it a windfall, but I'll let Tom talk about the mechanics you asked about.

Yes, in terms of trying to manage expenses, it's across the board, all the employees participating in things that they can figure they can delay. But that doesn't mean that there's a build-up expense thing, so they delay, well that's going to come and rush on. It's things that they can delay and figure out how we don't have to do. It's -- when we replacements, taking our time on replacing people. Which means employees here get to do a job and a half for somebody else. So that can save you a decent amount of money. We continue that here for awhile. In terms of other expenses, we are doing a big operation on upgrading all the investment management operations. That just takes time to figure out. There are going to be a lot of dollars spent there. But it is going to spent over the next three to five years. So there is no big ramp up that we are expecting there, either, on the technology side.

Okay, great. Thank you very much, that was it.

Robert Lee with Keefe, Bruyette & Woods.

Chris, maybe a question for you on equity flows and sales. So sales in a pretty tough environment, gross sales hold up pretty well. Could you maybe give us a little bit more color or feel for maybe which distribution points or channels you're seeing the most success in? And I don't know if it's the old Edward Jones channel or RIAs, but any color on your thoughts around where the distribution successes are and where they maybe opportunity is would be helpful.

Well, the first one I would mention would be that you remember a few years ago, we talked about adding to the sales force in order to call on the broker-dealer area, and that has worked out very, very well. Over the last couple of years, we've increased the number of advisors that are actually doing business with us is over 37,000 now. Back several years ago that was under 30,000. So that's been a very strong area for us. And it's both in the direct IRA business and in the regular broker-dealer business.

There's also been a big movement that cross hatches all of those areas and trust along the lines of retirement. And depending on who you talk to, because it's very difficult to get these numbers, and if I had good numbers I'd have good slides, but I don't. But the estimates are that you've got just under 50% or over 50% of the business coming in is retirement-type money. So that what happens is that when you do the hard work of getting on a platform, then you get the automatic investments, you get the reinvestments, and these are very, very important things. And it's almost like if you don't get on the platforms, you have a problem growing and existing. And if you get on the platform, continue the performance, and continue the service that goes with it, then that works very well too.

On the trust side, what's going on there, there's a lot of concern about the fiduciary relationship. And I'm not trying to get into the DOL thing on the broker-dealer side, but there is a lot of concern about, okay, what is our relationship with the clients? Are we following our duty of loyalty? Are we following our duty of prudence? And Federated does a lot of work on this as a value-add to the relationship that helps us very well in terms of the trust business. And then by stepping stones over into the broker-dealer and RIA business, to do everything we can to try and get clients ready for what the DOL may come up with.

All right, great. And maybe, I'm just curious we talked, obviously, a bunch about the money fund business. When do you think, putting aside what types of products institutions choose to go in, but you have a lot of bank that want to get rid of deposits, you've talked about that in the past. Maybe give us updated thoughts on your current expectations, when you may start to -- maybe you are seeing it or start to feel you'll start to see some of that cash move. Do you think it's more about 2016 or maybe year-end thing? Because you usually get a year-end surge and deposits to banks or money funds, just your thoughts on that one.

That one, Rob, is hard to put it exact thing on. Some of it has already moved into various elements, into the direct marketplace, for example. Some -- there will be an effort around year end, because the year end becomes important to some of those banks in terms of removing that money from their balance sheet, so that becomes another timeframe. And I think it has to almost wait until the full maturity of the October 16th deadline for implementation of the new rules, because that's when everybody really knows what everything is going to look like.

Now everyone of us who's in this business are going to try and get things organized well ahead of that. But that's the point at which I have said before that I think you begin to see meaningful positive flows coming back into the money fund business and growth all around. So right now, obviously, we're spending a lot of time, as are others, restructuring products, talking to clients, and they're trying to figure out exactly where to go. We sit down with all these big banks who also are trying to get people off of their balance sheet, and this is part of what informs our effort to create the products. But it's really tough to say exactly when you begin to see that money.

And Debbie has a follow-up.

The only thing that I would add is that as rates actually increase, historically, money market funds have lagged the direct marketplace. We've already started to see yields increase on money market product, despite the fact that the Fed hasn't made a move yet. But when that moves actually start in earnest, even if it's at a slow pace, the expectation is that money market funds are going to keep pace much more closely correlated than has historically been the case and that certainly that's when you're going to see deposit rates lag.

They're going to lag for two different reasons: number one, banks don't want those deposits any more, and number two, it's an administered rate, so they can figure out a way that makes it easier for them to shed them in a rising rate environment, especially when they're not keeping pace with that rise. So we do think that the rising rate environment will begin that movement process in little bit more earnest.

Great, and maybe one last question for Tom. This is a little bit of a modeling question, a follow-up to Ken's really. When we look at the moderation of fee waivers, I won't say recapture, it looks like most of that in your disclosures come out of -- has been -- come through advisory fees. If you look at other service fees, they have been remarkably stable. Or well, now you're waving it, the remarkably stable the last year-and-a-half, despite the improvement in the fee-waiver picture.

So is there -- I know there's a mix issue in there, but if we're thinking ahead and just trying to think about how this flows through the P&L, is it reasonable to think that hey, that one-third of waivers that you're not going to recapture that we may -- somehow that's going to play through the other service fee line as opposed to advisory fee line? I'm just trying to get at sense on how moving -- the pieces will move.

It's Ray. We have talked in the past about the distribution expense of being constant pressure, and we talked about that potential to happen with -- in terms of discussions with a particular customer, which are in flux and we don't know when or how that will play out. I do think looking at this line item this particular period with the waivers of the other service fees essentially going up, that does relate to the change in asset composition. So no, I don't know that I would get to the same modeling conclusion, but that's something we could talk about off-line.

Great, thank you for taking my questions.

Michael Carrier, Bank of America Merrill Lynch.

Thank you, guys. Chris, you hit a little bit on the DOL, but you got the DOL proposal, and then more recently the SEC's come out with the liquidity proposal. I know it's relatively early and all these are proposals, but I just wanted to get your take on like maybe the liquidity side. And then just on the DOL, when you look at the distribution positioning for Federated, where are the hurdles, based on the current proposal? And how do you think that you're positioned if this goes through?

Okay, we will do liquidity first. On the liquidity rule, our attitude is that there's some good things; there some not some good things, and there's some things that could go either way. The good things are that it's a principles-based operation, so you get to use your judgment on to what percentage of your fund should have three-day liquidity. And that is a very good approach.

And the judgments are to be based on a lot of data, a lot of which we've been utilizing here at Federated for some amount of time to do that kind of thing. Obviously, not with a precise number on the three-day. So disclosure on this is a positive. And targeting and maintaining liquidity levels is a good thing, because back in the old days when I learned about the Investment Company Act, the right of redemption was considered sacramental. So that's pretty good.

Now in terms of the things that aren't so hot, the idea that you can put all equity securities and all fixed income securities into six buckets, some based on business days, some based on calendar days, is a lot like measuring something with a ruler and then quoting it in inches. It just doesn't work well. And I understand that it's a great business for intermediaries to come in and say, hey, this is a wonderful thing to bucket everything. So I think there's some challenges with that.

The thing that can go either way is the swing pricing, a new concept. Obviously it's worked over in some areas in Europe. And my biggest concern about it is the timing and the investor education and understanding of what it will do. The swing pricing has positive aspects in that the outgoing investor pays the expenses of transactions at given amounts, and obviously, that has an enhancement to the overall performance of the fund.

But when you change the net asset value that you quote to everybody, and you don't know exactly what the rules are going to be because you're not supposed to tell people, then investors have a little bit of a challenge about knowing what their NAV is, either on the buy or the sell side. So we are going to comment strongly that it would be unwise for the SEC to allow swing pricing to be available immediately after the rule goes into effect, because I think it's going to take a lot longer in order to get people -- the investing public up to the point where they'll understand what is going on. So that's a real shorty on liquidity.

On the DOL, our view is that based on Perez's statements that they are going to do something, and despite the logic of waiting for the SEC to come up with a fiduciary rule and having only one standard instead of what amounts to three, which will be a DOL standard, a state law standard, and an SEC standard, I think they're going to proceed. One of our comments to them has been that the whole focus of the DOL approach has been on the cost, which has to do with the duty of loyalty and the duty of care, and not really much on the duty of prudence.

And the prudence question is not answered by cost. And the prudence question is a very important aspect of the whole fiduciary relationship, and this simply hasn't been addressed. So we are having a conference on this coming up in mid-November. We've sent our comments in to the SEC -- I mean to the DOL on this, and whether this will open up things to another level of discussion, I don't know. So that's our view on the rule.

Now, because of what I said earlier about our experience and trust in the work we've done on the subject, we are in a very good position to help clients understand what needs to exist when, as, and if that rule comes out and puts a fiduciary burden on broker-dealers. And I think we will be in about as good a position as anybody to help clients in this regard. At least that's what we are preparing for.

Okay, thank you. And then, Tom, just a quick follow-up. When you gave the waiver outlook in terms of that two-thirds number, I don't think that changed. I just wanted to make sure, because I think when I was just looking at it what you said last quarter, it seems pretty similar. I think you were just saying that when the new client -- when that starts, that relationship and that's what you're expecting versus maybe the current 75%. But I just wanted to make sure we had that right.

Yes, you're right. It was -- we started out at 75%, but that might have been a couple of quarters ago.

Got it, okay. I just wanted to clarify. Thank you.

Surinder Thind, Jefferies.

Good morning, just a couple of different things to touch base on here. One is just going to be simply expenses. Can we talk a little bit about the professional services outlook going forward? Obviously, related to the regulatory activity of the last few years and what's been going on that has been elevated, how should we think about that in the outlying years in terms of 2016 and beyond?

I'd love for to say we should drop that as things drop off, but it never seems to happen. Something new comes up, and I'd just -- I'd be hesitant to model big drops in that line.

Okay, but it has been -- there was a big step up in, I want to say 2013 I believe, and I think it's been trending down a little bit since then> Is that a fair trajectory or are we more at a normalized level for where we think things are at this point?

I think we're at a fairly normalized level, Surinder. The best thing to do would be to take multiple quarters of it and average it out, because as your question indicates, in any given quarter, you can see considerable variance there based on use of consultants, outside lawyers, etc. So it's probably best just to take that one over a period of time from maybe the last year or so and use that as an average.

That's helpful. And then the other thing I wanted to touch base on is you've generally had good success. A few different products that you've mentioned or areas, and whether it was EFA or value or growth. Can you maybe talk a little bit about the success of the Kaufmann Large Cap and why or maybe you've seen success there. I know that's a product that's done really well in terms of its relative rankings versus peers. But there's also other products out there, similar products in that segment, that also have strong track records but aren't seeing the level of success that you are in that product.

Well I can't address why others don't do as well with similar products. I will make this observation, that there are always in this industry four- and five-star products that don't have positive flows. And the reason for that is usually that the sales effort is not up to the performance of the fund effort. And so, as you might imagine, you're going to hear my activity on the fact that we have over 200 salespeople who are telling the story.

And especially in the Large Cap Kaufmann area, remember that they got their start in the Mid Cap area and then went into Small Cap and then into Large Cap, so that they have a long, long, long, worthy history of excellent performance in the growth area. And I think just telling that story, there is no magic catalyst other than checking out the companies and doing what you've been doing for literally decades, and you repeat this sounding joy and repeat the sounding joy. And if the performance is there, then the investors are very attracted to it.

And then maybe related to that, in terms of the commentary around the sales force, how should we be thinking about maybe headcount or increasing distribution or penetration and stuff or any thoughts around that?

There may be small numbers of incremental ads, but nothing that would approach double digits. We have, what, 210 now, 214, I think 214 is the number we are using now. And we are always looking for little pockets here and there. We did talk about some additions that we were planning on the international side, because of our growth in Canada and planned activity in Central America. We might add somebody overseas, too, as well, but it's all onesies and twosies; there's no double-digit plan.

Fair enough. And then maybe one final question, just on your outlook in terms of like the seed portfolio and stuff. I know you mentioned you're adding product and stuff. How should we think about that longer-term, in terms of, how comfortable are you guys with the breadth of product you have currently and maybe versus where the market is going? Or obviously we've seen a lot of commentary around like liquid alts and some other products. How do you think about those things?

Well, we think those are important things for the future, which is why a couple of years ago we hired a fellow called Michael Dieschbourg and reorganized the [$1.6 billion] or [$1.7 billion] of assets into an alternative area. And that's why I highlighted the Absolute Return Fund and commented on the Managed Volatility II Fund. And the analogy I've used on these calls before is that way more than a decade ago, we came up with a theme and a group of funds called the power of income.

Strategic Value Dividend was one of the leaders in that space; it included equity income and capital income, as well and others, but it was a whole movement. And the way we're looking at it is that these alternative products have been potential, in our view, to grow into a situation similar to what those power of income funds have done. But it takes a lot of time. The immediate catalysts don't cause geyser eruptions, but they are steady growers and that's why we like to highlight the ones that are attracting assets and developing one- and three-year records. So we would be -- view ourselves as betting on the growth of the alternative space very strongly.

Okay, thank you.

Eric Berg, RBC Capital.

Thank you and good morning.

My question is going to be purposefully high level and general. Listening to a number of companies in this sector, including yours, you would think that the challenges are very great, maybe not a fire drill but that the challenges are very great, and that in general terms, the state of the business today is more difficult than it was a few years ago. At least that's my take away; this is sort of the tone, that we're in a very, very difficult time.

But I'm trying to understand whether that really is the right inference to draw. Is the business generally speaking of money management in worse shape than it was a few years ago? After all, interest rates really haven't changed all that much this year. The stock market really hasn't changed all that much this year in the United States. Yes, emerging market prices have collapsed, but some people view that as an opportunity; volatility, people make money off of volatility. So that's my question: given everything that's going on, is it more difficult and more challenging to be running your business today than it was a year ago or three years ago?

Since 2008, rates have been dramatically lower than we had experienced for years. We have been challenged in managing in that environment. And so 2008 till 2015 is enough time to get used to it. And so, yes it is challenging, but we don't feel like we are in some crisis, and we are managing through it and properly.

We've obviously, our earnings are depressed based on where rates are, and we have dealt with that in a fashion that allows us to continue to invest in the future, like Chris talked about Dieschbourg and seeding other products and trying to make sure that we are set up for growth, and yet still have a respectable margin and a respectable earnings. So sure, it's a challenge, but basically, we're used to it.

Chris probably has a follow-up too.

Yes, it is more challenging in these senses: every time you turn around, there's another gang of regulation. So we've been through redo the whole thing on money market funds, which to the people working on it is truly water boarding, as we were told by one of the commissioners it would be. We are now dealing with the liquidity rule. We are now dealing with a fiduciary rule, and the SEC has said they are going to come out with a derivatives rule before year end.

Well, even though these challenges are greater, there are other things going on. Early on when we were going public in 1998, I talked about the potential of the triumph of investment advice as opposed to the do-it-yourself. All of these things point towards the need for the advisor, and that's the gang that we're betting on is the intermediary and the advisor. This is one of the chief problems of the DOL proposal is that it will tend to lessen, diminish, if not eliminate advise for people that don't have substantial balances of money.

The other effect of this regulation, which is most unfortunate, but nonetheless you deal with it, is that it oligopolizes the business. You can see it clearly in the money fund business, but it makes it more and more difficult for other players to get in. And when you look at what the responsibilities you have on the distribution side, it's not only all oligopolized in the sense of creating investment management operations, it's oligopolized in the sense of getting onto platforms, as I articulated earlier. So I can at once say that it is far more challenging and say that we are very happy with where we are and with our growth prospects; at the same time and would still contend vigorously that this investment management business is a great business.

Very, very helpful. I hope to talk to you more about this. Thank you to both of you.

Patrick Davitt, Autonomous Research.

Good morning, thank you. My question is on the 4Q waiver guidance. And maybe you could remind us how to think about that relative to the way short rates track, because I would've thought there might be some reversal there given the way short rates have tracked. So any kind of color how to think about that relative to the way the short rates track?

I'll just give you the technical points behind the modeling, and then Debbie can talk about our outlook for rates. Basically, we're looking at the overnight repo rates being in the mid to high single digits, and that's really one of the more critical factors when we look at where we think the waivers are going to come out. The other comment I would make, if you look at the asset growth, remember that waivers are both a rate and a volume calculation with the asset growth we had in the third quarter, and again with the acquisition in there. It was mostly on the prime side where, of course, waivers have even over the last several years not been much of an issue.

So but Debbie can comment on where we think rates are heading.

Sure. From a repo perspective unchanged there, in the single digits, as Ray mentioned. From a LIBOR-based securities perspective, so this would include government agencies, commercial paper, CDs, floating rate securities, those rates are also fairly unchanged, maybe up a couple basis points despite the fact that the Fed missed the market and didn't move in September.

Treasuries are a little bit mixed at this point, just given what's happening from budgetary discussion perspectives. Depending upon what treasuries you're looking at, they could be almost trending negative to trading high double digits. So it's really hard to make an estimation there, but we're confident that the budgetary process will move forward and get past. So all in all, you're looking at rates that are, for the most part, unchanged to maybe 1 or 2 basis points higher, and therefore, the expectation is that the waiver is very similar.

Okay that's helpful thank you. Then just a point of clarification on your prepared comments, the flow numbers you gave at the very beginning were as of October 16th and the asset numbers were as of the 21st?

Correct

Okay, thanks a lot.

Thank you. There are no further questions at this time. Mr. Hanley, I'll turn the floor back to you for any final remarks.

Well thank you for joining us today. That will conclude our call.

Thank you, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.