Federated Hermes Inc

NYSE:FHI

Earnings Call Transcript 2017-Q4

[Operator]

Greetings, and welcome to the Federated Investors Fourth Quarter 2017 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, Ray Hanley, President, Federated Investors Management Company. Please go ahead, Mr. Hanley.

[Raymond Hanley, executive]

Good morning, and welcome. Leading today's call will be Chris Donahue, Federated's CEO and President; and Tom Donahue, Chief Financial Officer. And joining us for the Q&A is Debbie Cunningham, our CIO of the Money Market Group.

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?

[John Donahue, executive]

Thank you, Ray. Good morning all. I will briefly review Federated's business performance, and Tom will comment on our financial results.

Looking first at equities. We closed 2017 with record-high assets of $68 billion. Solid investment performance and strong markets drove equity growth of $1.1 billion from the prior quarter and $5.8 billion for the full year. Funds with positive net sales in Q4 included MDT Small Cap Core, MDT Small Cap Growth, Kaufmann Small Cap, International Leaders and Muni and Stock Advantage. We also had half a dozen other funds with modest positive flows in the fourth quarter.

Using Morningstar data for the trailing 3 years at the end of '17, 3 Federated funds were in the top decile, 8 funds or 35% were in the top quartile and 52% were in the top half. Trailing 1 year rankings showed 5 top-decile funds, 13 in the top quartile and 18 or 3/4 of the funds above median.

In four-star land, all 3 Kaufman funds are four-star, as is the MDT Small Core, MDT Small Growth, MDT mid value, MDT mid growth, Muni and Stock Advantage, Global Al and our index products. Strategic Value Dividend is three-star overall and four-star for 3 years. Top-quartile trailing 3-year equity strategies at the end of the quarter included MDT Small Cap Core, top 1%; Kaufmann Small Cap, top 3%; MDT Small Cap Growth, top 3%; and the regular Kaufmann Fund, top 11%. Strategic Value Dividend is 28% for 3 years.

Three weeks into Q1, net redemptions of equity funds are approximately $194 million and equity SMA net redemptions are about $46 million. The strategic value dividend fund has had net redemptions of about $116 million through the first 3 weeks of January while the SMA had about $30 million of net redemptions. We have seen early Q1 positive net sales results in MDT Small Cap Core, International Leaders, MDT Small Growth, Kaufmann Small Cap and Muni and Stock Advantage.

Turning now to fixed income. The new large public institutional mandate we discussed in our last call drove combined fund and separate account net assets at net sales of $11.1 billion. Funds with net sales included Institutional High Yield Bond, Total Return Bond, the Ultrashort Bond Fund and the Federated Bond Fund. Our fixed income business has a variety of strategies that are performing well. At year-end, using Morningstar data, our high-yield bond and Total Return Bond Funds were in the top 10% for trailing 3 years. The Total Return Bond Fund was top quartile for the trailing 1, 3, 5, and the 10-year slipped down to 26%. In total, we had 7 fixed income strategies with top-quartile 3-year records at year-end, and others included Federated Bond Funds, strategic income, Ultrashort and intermediate muni. Fixed income fund net sales are positive early in Q1 to the tune of $128 million.

Looking now at money markets. Total money market assets increased by $21 billion from the third quarter. Separate account money market assets were up nearly $14 billion, reflecting about $6 billion from the new public entity mandate and growth in existing accounts from seasonality and other factors. Money market mutual fund assets grew by nearly $8 billion, reflecting seasonality and other factors.

Our money market mutual fund market share, which, for our purposes, includes some sub-advised funds, at the end of the year was 7.4%, up slightly from the prior quarter of 7.3%. Prime money fund assets increased about 1% in Q4, up to $28.7 billion. Assets in our prime private liquidity fund increased over $500 million in Q4. This product and our prime collective fund had about $850 million in combined assets at year-end, up from $600 million at the end of 2016. These products preserve the use of amortized cost accounting and do not have the burden of redemption fees and gate provisions.

Taking a look at our most recent asset totals as of January 24. Managed assets were approximately $403 billion, including $268 billion in money markets, $70 billion in equities, $65 billion in fixed income. Money market mutual fund assets were at $181 billion, which is about the same as the average so far here in January. In the institutional channel, RFP and related activity levels continue to be solid and diversified, with interest in MDT and dividend income for equities and high yield and short duration for fixed income. We began Q1 with about $140 million in wins yet to fund.

Total SMA assets ended the quarter at an all-time high of $27.2 billion, an increase of about $3.6 billion or 15% during 2017. Our SMA business produced $1.3 billion in gross sales and had $136 million in net redemptions in the fourth quarter. Federated ranked fifth in the Dover rankings, which I've given you before, of the largest SMA managers at the end of the third quarter.

On the international side, we continue to progress on the launch of our new efforts in the Asia-Pac region, with a focus on opportunities in Greater China, Korea and Japan. We are looking to grow strategic relationships with financial institutions and add regional distribution of Federated investment strategies. This effort complements our European, U.K. and Canadian operations.

Total assets in the international division grew by 11% in 2017 to nearly $16 billion. Assets in our U.K. operation grew by 22% to reach $5.6 billion, the highest total since the 2012 acquisition that launched that effort. We also saw double-digit percentage growth for 2017 in Germany, 16%, to push the number over $3 billion; and Canada, 14%, to push the number over $2 billion. We continue to seek alliances and acquisition to advance our business in Europe and the Asia-Pac region as well as in the U.S. and the rest of the Americas.

[Thomas Donahue, executive]

Okay, Chris. We'll move to the financials. Total revenue was about the same from the prior quarter. Higher advisory and administrative service fee revenue due to higher average assets was offset by lower other service fee revenue due to lower money market distribution fee revenue. The lower money market distribution fee revenue was offset by related lower distribution expense. Revenue was down 4% compared to Q4 of last year due to the previously discussed change in a customer relationship in January 2017 and lower money market fund assets. These decreases were partially offset by an increase in revenue due to lower money fund yield-related waivers and higher equity and fixed income-related revenues from higher assets. Q4 2016 revenues also included the positive impact of approximately $3 million related to a nonrecurring fee credit from a fund service provider.

Equities contributed 43% of Q4 revenues, and combined equity and fixed income revenues were 60% of the total. Operating expenses decreased 1% compared to the prior quarter and decreased 9% from Q4 of last year. The decrease from the prior quarter was due mainly to lower money market distribution expense related to asset mix changes. The decrease from Q4 2016 was driven by the impact of the customer relationship change and lower money market fund assets, partially offset by higher distribution expense as money market funds' yield-related waivers decreased.

An early estimate of Q1 comp and related expense is about $76 million, up from about $72 million in Q4, due largely to seasonality around payroll taxes and benefit expenses. Looking ahead to Q1, the combined impact of fewer days and higher estimated comp and related expense is expected to result in about $8 million in lower operating income compared to Q4, all else being equal.

Looking at taxes. For Q4, we had a $39 million tax benefit. This included the revaluation of our net deferred tax liability related to the Tax Cut and Jobs Act of 2017, which reduced our deferred tax liability by $70 million. For 2018, an early look at our combined federal state and local tax rate is estimated to be about 24% to 25%, but remember, it's early and it's only an estimate.

We maintain the same priorities for use of capital: acquisitions, dividends and share repurchases. While we are continuing to evaluate the impact of the lower tax rate on available capital, we expect to maintain a similar dividend payout ratio. At quarter end, cash and investments were $370 million, of which about $340 million was available to us. We continue to be active on the share repurchase front with 197,000 shares purchased in Q4.

Rob, that completes our prepared remarks, and we would like to open the call up for questions now.

[Operator]

[Operator Instructions] Our first question is coming from the line of Ken Worthington with JPMorgan.

[Kenneth Worthington, analyst]

Maybe, first, just a couple of questions on the money market fund separate account. So as we look in this quarter, some of the increase was the $17 billion mandate win, and then you mentioned the seasonality. I assume that's around the state pools. In terms of the growth that we're seeing there, ex the big mandate win last quarter, what portion is coming from the state plans and what is coming from maybe like all other business outside of state plans? Is it really the state plans that are continuing to allocate money to Federated? Or is it also including a significant portion of other things? So start there.

[John Donahue, executive]

Ken, it's Chris. It was supposed to be the state pool money that we manage, which has some tax seasonality to it.

[Deborah A. Cunningham, executive]

I would add, though, that there is a broader array of clients that are coming into those state pools at this point in time and causing that volume to be higher on an increasing basis than normally from the seasonality standpoint.

[Kenneth Worthington, analyst]

Debbie, can you flesh that out? What do you mean like new types of clients coming into the state plans?

[Deborah A. Cunningham, executive]

Not necessarily new types. So the state plans themselves are very specific as to the types that they can accept, but a broader group of clients. So more different -- more indifferent school districts, municipalities, various other types that can go in, just a broader array of those underlying clients.

[Kenneth Worthington, analyst]

Got it, okay. And then on the distribution and marketing expense, it was down, I think, by about $4.5 million this quarter. And I believe you guys mentioned that part of that was the other service fees coming down and sort of the pass-through element, but that was only down $2.5 million. Maybe can you flush out more the mix change that's going on and maybe the direct driver of that big decline from last quarter -- third quarter to fourth?

[Raymond Hanley, executive]

Well, Ken, you have other things in both of those line items. So in terms of the revenue item, there, it does -- it's affected by equity and fixed income as well as money markets. So it's the same kind of mix shift that we talked about last quarter. We had lower assets coming from the more retail sweep type of applications, which have higher distribution fee revenue and related distribution fee expenses. And so those 2 things move proportionally underneath, but again, there are other things in both of those line items.

[Operator]

Our next question comes from the line of Ari Ghosh with Crédit Suisse.

[Arinash Ghosh, analyst]

So your core expense management continues to be really tight. But just looking at 2018, could you help think about some of the new investments and expenses that could filter through here? Just trying to think about a good run rate for core expenses ex of comp and distribution.

[Thomas Donahue, executive]

Okay. So comp, we gave you a Q1 number, and that's about as far as we'd like to go on there. And of course, that's an estimate just for Q1. The -- we've -- advertising and promotion, we -- in the budget process, we probably will uptick that number for 2018. Travel and related line item, I don't see much of a change there. Office and occupancy probably is going to go up as we continue to expand a little bit. Systems and communications will probably be a similar number. Professional service fees, I don't see much change in there. And the distribution, well, that flows with what Ray just went through, how our sales and the related distribution expense is going. We continue to -- in 2017, we had a significant effort in the company to make sure we manage things properly and continue to try to grow and we'll continue to do that in 2018.

[Arinash Ghosh, analyst]

Great. That's really helpful. And then just on the separate accounts side, could you -- was that from an existing client or a new relationship? And then, do you have any visibility into potential new fundings in 1Q on the money market side that could maybe help offset some of the typical money market industry weakness that we typically see? Just curious.

[John Donahue, executive]

That was not an old client. That was a new client. We are not yet at liberty to release you the name. And Debbie will tell you about the first quarter.

[Deborah A. Cunningham, executive]

For first quarter, I think we'll probably continue to have its regular seasonality. It's aided this year, though, by the fact that the interest rate environment that we're in is no longer at 0. 1% and 2% type securities in the market for money markets are actually prevalent at this point, and the funds are returning something that is producing income for their clients -- their underlying clients. So our expectation is optimistic for what the first quarter will produce.

[Operator]

Our next question is from the line of Patrick Davitt with Autonomous Research.

[M. Davitt, analyst]

Is there a subset of the $186 billion in fund -- money fund assets that you think you've identified as potentially transferring to the separate accounts? Even a rough range would be helpful. I imagine there has to be some base of assets that wouldn't be eligible.

[Thomas Donahue, executive]

Yes. We saw some of that activity, Patrick, around money fund reform and then we saw particular client change. Even though the money stays in a fund from the customer's perspective, it became a separate account to us because we became a sub-adviser. But we don't have really -- we don't expect nor do we foresee any meaningful additional conversions from the money market fund side to the separate account side.

[M. Davitt, analyst]

Okay, great. And I'm sorry, I missed this earlier, the guided tax rate post tax reform?

[John Donahue, executive]

Okay. Estimated, with the 5 hedge words around it, 24% to 25%. It just -- things change, and put that out there, just really in the quarter.

[Operator]

Our next question comes from the line of Robert Lee with KBW.

[Robert Lee, analyst]

I'm just curious. Going forward, you have the -- obviously, the benefit of lower taxes, and you have been pretty tight on expense controls. But can you maybe talk a little bit about if you see any need or pressure or maybe have any intentions of maybe ramping up -- or see a need for ramping up investment, whether it's in kind of infrastructure? Or -- you have your non-U.S. distribution initiatives. Just trying to get a sense if you think you maybe see a need or opportunity maybe to spend part of the tax windfall that's coming.

[John Donahue, executive]

Well, first of all, it's not a windfall. But the answer to your question, we continue to look overseas for acquisitions, and that remains the highest and best use of monies. On the other hand, we do not feel constrained whatsoever about anything that we wish to do in addition. So other programs, whether it's technology or pricing or this or that or infrastructure, any of that, all have their own independent analysis unrelated to the tax changes.

[Robert Lee, analyst]

Okay. And then maybe as a follow-up, you have, I guess, a range of kind of small cap-oriented products where performance has been good. And Chris, as you mentioned, it seems like demand has been good, and flows have been positive. Are any of those products facing meaningful capacity issues here? Market has been up. Flows have been good. I mean, do you feel like you have enough capacity in the in-demand products over the coming year?

[John Donahue, executive]

We're in good shape on all of those products on capacity, and we go over that pretty strongly. And don't forget that the PM has the lion's share of the vote on what happens there when, as and if you get to the time of a limit. But we're not at or near a limit.

[Robert Lee, analyst]

Okay, great. And maybe one last question, if I could. I know you clearly gave some color around state plans and the liquidity and what you're seeing there, but can you maybe dig a little deeper into the broader money fund business? Which distribution channels do you feel like you see the most opportunity, as rates have backed up, to kind of pick up assets? Or where do you see kind of the potential -- the current or potential pockets of strength or weakness, on the other hand?

[John Donahue, executive]

I'll answer it one way. Debbie will have another answer. But what I like is the possibilities of our bill that we have supported, 2319, which basically says let's go back to the thrilling days of yesteryear on amortized cost, institutional prime and institutional muni funds, wherein $1 trillion is left. So there could certainly be a $1 trillion comeback. And when you throw all the money up in the air, that's usually a good thing, especially for those who are in favor of doing this. Why? For the benefit of the clients who have all lost their 30 basis point spread by having to be stuck into a government fund, where they don't get the 30 basis points of vigorish that's associated with a prime fund. So if this thing marches through Congress, this would be a big effort for us. Debbie?

[Deborah A. Cunningham, executive]

From a theme standpoint, I think what we're looking at for 2018 is the performance of money market funds in a rising rate environment versus deposit products. So deposit products currently stand at over $11 trillion, whereas the money fund industry is slightly under $3 trillion at this point. If you go back to the financial crisis in 2008, both products stood right around $4 trillion at that point. In a rising rate environment, however, because deposit products are administered rates, whereas money funds follow market rates, typically, market -- or money market funds perform quite well versus their deposit products. So that's basically where we see a lot of growth coming from. In fact, on a 1-year basis, if you look at the growth rate in deposits and the growth rate in the fund industry, it's the first year in the last 10 years where the fund industry grew at over 4% and the deposit industry only grew by 3.3%. So not a whole lot of difference, but there was a difference, and we exceeded at that point. So that's our theme for 2018, and we think that there's a lot of cash to move from that specific area.

[Robert Lee, analyst]

Do you think that there's specific channels where you have more opportunity? Like -- I know you have the broker/dealer channel. You kind of have corporate channel, different institutional channels. Is -- are there -- in one channel or another, do you see more opportunity?

[Deborah A. Cunningham, executive]

Well, it certainly seems as though some of the corporate side of the equation, especially from a repatriation perspective, has a lot of opportunity associated with it, cash dollars that might be flowing back into the United States because of that tax bill, sort of another aspect of the tax bill. Also, when you look at some of the sweep products that went into government money market funds, as Chris was mentioning, some portion of that or [ sac ] lending assets become comfortable again with prime money market funds. Those will likely grow also in 2018. So there's probably not a channel where we feel at all constrained or as if their growth might be stagnant. It's all looking pretty positive at this point.

[Operator]

Our next question comes from the line of Michael Carrier with Bank of America Merrill Lynch.

[Michael Carrier, analyst]

I guess, first one, just on fixed income and money markets. Debbie, I think you mentioned, in the quarter, a pickup on the prime side. But just given what we're seeing across the rate markets, just wanted to get a sense -- like where are you seeing more like client demand? And Debbie, you mentioned the deposits versus the money markets and starting to see some interest there. But even maybe some of the money that went to fixed income products, are you starting to see that shift around? And then any other new launches across the money market platform?

[Deborah A. Cunningham, executive]

In 2018, it seems as though we started to see some cash flow in from equity and longer-term fixed income investors. That was not the case in 2017. That's a very new, in the last couple of weeks, phenomena. And I think, to some degree, it has to do with expectations for where those markets are going or maybe a little bit of concern about where those markets are going. Having said that, I don't look at that as a big avenue of growth for 2018. I think, again, going back to sort of the repatriation side, certainly, there's been a lot of announcements by various firms, Apple, in particular, last week; some other technology firms; Starbucks. Different ones have announced some, at least, initial plans for where some of those -- that cash flow will be placed. We think that will be a substantial area of growth in 2018. And generally speaking, I think winning back clients that, for purposes of, initially, the financial crisis and concern about the fund industry versus the banking industry, went into deposit products, again, will be something that we continue to focus on in 2018 and, we think, has a lot of upside potential associated with it.

[Michael Carrier, analyst]

Okay. And then, Chris, maybe just on the M&A front. If we look at the industry overall, there has been more activity over the last 2 years and there's a lot of kind of drivers to that. Just wanted to get your sense. When you look at the landscape, are you seeing more like opportunities or sellers out there? And does it create more opportunities for Federated? Or is it kind of business as usual in terms of how you guys think about the inorganic growth for the business?

[John Donahue, executive]

I would characterize it more of the latter than the former. Trying to use me as a gauge for how many deals there are and how much life there is in the marketplace is not all that accurate. Because what we look for are those deals that match up with us culturally, distribution-wise, performance-wise, excellence-wise, et cetera, and this drives the truck for us. So it is an inexorable search for those types of entities that match up on all those criteria.

[Operator]

Our next question comes from the line of Bill Katz with Citi.

[William Katz, analyst]

Tom, just wanted to clarify before I ask my immediate questions. Did you mention there was a $3 million onetime revenue item this quarter? Or was that relating to a different quarter? I apologize, I just missed that.

[Thomas Donahue, executive]

They're last year's quarter.

[William Katz, analyst]

Okay. All right. Bigger-picture question, Debbie or maybe someone else, as you think about the money market business, based on your update, it looks like you had a sequential decline in the money market mutual funds and a pickup in the separate accounts. So as you think about some of that growth that you highlight in terms of money potentially coming back to the banking system with deposits generally, would you expect separate accounts to grow a little bit faster than the mutual funds? And why aren't you seeing a pickup on this growth rate? What kind of rate level do you think you're going to need to see a more substantial increase in the money market mutual funds?

[Deborah A. Cunningham, executive]

I think that the separate accounts are likely to be driven by the need of our underlying local government investment pools, and those are seasonal. So those are being driven right now by the inflows that are coming into those particular entities, but that will be reversed sometime this quarter. Having said that, again, because of higher rates and because of broader participation within those pools, we think those levels will be higher in 2018, even as they start to go out and go back into the participants. From a money market fund standpoint, we do think that the growth that we're anticipating there is substantial. Certainly, it seems as though there are quite a few clients who are dipping their toe back into the prime world, the prime institutional world in particular. We have funds that were decimated in size from a regulatory environment but at this point -- in the fourth quarter and second half of 2017 grew more than 50%. Now it's 50% off of a small base, so it doesn't create the same amount of dollars sometimes as what you might be thinking of in the context of 50% growth. Having said that, that seems to be a swell that's growing, and our expectations would be it will continue in 2018 and probably pick up speed just simply because of the additional return that's coming and expected as the Fed continues on its path toward normalization and what I'd say is probably a 2% rate environment.

[William Katz, analyst]

Do you think there's any difference -- sorry to drill on this topic. But do you think there is anything different about your business model? The reason I asked is some of your peers have announced some pretty substantial growth in their money market business, and they don't break it out as much detail as you do. But I'm just surprised, even with seasonal dynamics, that your money market mutual funds aren't up more at this point in time. And I'm just wondering why you're seeing a sequential decline from the end of the year.

[Raymond Hanley, executive]

Well, Bill, that's nothing unusual. We tend to have money come in late in the year. And if you look at the period-end number versus the average, you can see that and then to have it go out in the -- we're dealing with the first 3 weeks of the year. So I -- that's been our pattern for a number of years.

[William Katz, analyst]

Okay. And just one last one. Chris, you mentioned your sort of appetite is, first and foremost, outside the United States. Could you talk a little bit about where you're spending most of your time, whether it be geographically or by product? And how are you thinking about incremental sites to notch on to your platform?

[Thomas Donahue, executive]

So this is Tom, Bill. We've always looked to go to Europe first. It's -- the language makes sense. We already have our LVM relationship, our German operation, our U.K. operation, our UCITS funds. And so that's been our base and our focus and our beginning. Now remember, we've hired the group that calls in the Asia-Pac area, and they are out and going strong and having significant meetings. And so not to put them in second place because if they -- if we -- if they bring something that makes sense to us, we absolutely are going to be energized on that. But you asked us to rank it. So we're focused and really charged after Europe first, and then Asia-Pac would be the second. And of course, not trying to ignore Latin America and Canada in our distribution efforts there either. Chris, I don't know if you have anything else?

[John Donahue, executive]

He asked where I spend my time. I got 4 grandkids in London, so take a guess.

[Operator]

Our next question is from the line of Brian Bedell with Deutsche Bank.

[Brian Bedell, analyst]

Maybe, Tom, if I could just start one on expenses. Thanks for the sort of the outlook for 2018. A couple of things. Just on -- and sorry if I missed this, the jump in professional service fees from 3Q to 4Q. And then your professional fee guidance for 2018 is sort of flat. Is that on that full year so that increased level? And then also, on the distribution expense, obviously, that's been coming down as you guys have been talking about. Is that $80 million fourth quarter run rate a good sort of base to model off of for 2018?

[Thomas Donahue, executive]

Yes. I'll do the professional fees, and Ray can do the distribution. So we kind of look at that professional service fee over a year. We don't know exactly when things are going to come in, and so I think that the year-to-year and a quarter versus a quarter, I don't think it's worth getting into. And would we expect that number to go up? It went down a little bit in '17 versus '16. And so would it go up a little bit? Possibly. But when I went through the list of expenses, I didn't have that one as one that we have budgeted for increasing, but things happen.

And distribution, Ray?

[Raymond Hanley, executive]

On distribution, Brian, yes, it's a good number to model from based on these asset levels and the mix of assets even more importantly, which is hard for you to see through to that. But there was not anything unusual about that number for Q4.

[Brian Bedell, analyst]

Okay, great. And then maybe just moving on back to the money market funds and maybe just another angle of this. Obviously, it looks like there's a lot of drivers for potentially good demand. Maybe either Debbie or Chris, if you can talk about your sweep money market fund arrangements. I think, if I'm not mistaken, it's around $60 billion at the brokerage. It was -- correct me if I'm wrong on that. But as you see that dynamic playing out -- there's a lot of dynamics within that. There are obviously some broker-dealers converting sweep over to bank deposit. And then, of course, like you mentioned, you have the dynamic of people purchasing money funds -- or moving to purchased money funds from sweep that have potentially higher yields. If you could talk about those 2 dynamics within the context of demand for 2018.

[Deborah A. Cunningham, executive]

That is a dynamic that was -- has been in play for the last 6 or 7 years. Initially, there was a large movement of sweep products into deposit products. And then, most recently, in the last 2 years, it's been a movement from prime funds into government funds, mostly having to do with the gates and fees and the concern from a sweep product perspective about those aspects of the prime institutional fund. And again, we're starting to see both of those things reverse. And although there have been some conversions still into the bank deposit market, it's been fewer and far between. And again, we think that rates ultimately will drive that equation. And even from a government money market fund standpoint versus those deposit rates, there's a lot of interest, and the competitive nature, the comparison is very good coming in toward -- with the government money market fund on top. For those -- and we've had a handful of customers that have gone back and readdressed the whole gates and fees idea within the sweep product aspect and have gotten comfortable with it and have updated their systems to be able to handle that aspect, even though it's unlikely and remote. And as such, we're beginning to see a very small flow back into there. We think that will grow as 2018 continues.

[Brian Bedell, analyst]

Okay. And then maybe just lastly, if you could handicap the bill 2319 getting approved this year, and if it does, how -- if you can sort of talk about the tempo of maybe the shift back into prime. Would it happen pretty much, do you think, right away? Or would there be a substantial lag?

[John Donahue, executive]

I think it would be more or less a lag, but I wouldn't have used the word substantial. And the reason is that you got to burp out all the new products, and so that's going to take a certain amount of time to get them around. Then the products have to be big enough where the clients can feel comfortable with their normal positions. So you're going to have to grow your way back to nirvana where they were before. So that's how I would see it. But it is so clear that the customers, the issuers and the marketplace prefer that product. I mean, that's why they moved $1 trillion from prime to govie. So I have a lot of confidence that, that money will come back. As to making book on it, I throw around the idea that once you've been marked up, it's a coin flip. But gee whiz, you can come up with anything you want as to what is going to happen in Congress, and I'm not going to dispute it with you, argue it with you or come up with a different view.

[Operator]

Our next question is from the line of Surinder Thind with Jefferies.

[Surinder Thind, analyst]

Just following up on some earlier questions, starting out with M&A. At what point does it make sense to be more aggressive with that growth strategy? You guys have been talking about M&A, especially international M&A, for a while now. And then how should we think about it in terms of your pursuit of maybe something more transformational versus trying to do a number of smaller deals?

[Thomas Donahue, executive]

So we're going to stick to our criteria. And yes, we have been talking about it for a long time, and we've been talking about it internally longer than we've been talking to this group about it. So it's longer to us than it may even seem to you. But in order to make it work at Federated and make it work for the shareholders and for growth, we're going to stick to our criteria and we'll do something that we believe makes sense and is good for the long-term value of the company. It's a...

[John Donahue, executive]

It's never a question of being "more aggressive." It is only a question of whether the deal is right.

[Surinder Thind, analyst]

I guess the question I would have is, so what tends to be the criteria that you fail at, in the sense of the criteria that isn't met? Is it pricing? Is it cultural? What is the challenge that is most difficult?

[John Donahue, executive]

Yes. So each one that we don't pursue has different aspects that don't make sense to us. Gordie Ceresino, who's running this on the international side, has set out the criteria that includes management that wants to stay active and involved in the company. We look at -- so that's a big deal of criteria. The performance of the funds or the mandates or how they manage money, the thought process in terms of culture of how they treat their customers, those are all big, important things. So various deals that don't work out with us don't make it on different -- for different reasons. And we acknowledge that after all these years, yours truly has lost credibility on saying we're doing it. But believe me, we are doing it. It's just that we don't feel like we have to do it. But I realize where we are on this, so I don't -- I'm okay with it.

[Surinder Thind, analyst]

Fair enough, fair enough. And related to that, obviously, you talked a little bit about the capital return and increasing the dividend in relationship to the incremental benefit that you're going to get from tax reform. But how should we think about share repurchases? Obviously, you said the M&A is the first criteria, if you're able to meet that. Would you be willing to let cash build? Or is it kind of if, by the end of the year, you don't see anything developing, then a big chunk of the money will go towards share repurchases?

[John Donahue, executive]

Yes. So since you put a time on it, we're not answering you. You said end of the year. We don't have...

[Surinder Thind, analyst]

Well, I'll maybe -- okay. So let's not put a time on it then.

[John Donahue, executive]

Right. I will answer it anyway, but not with a time on it. And if you look at our history, we have -- the word cash build, and so with no amount and no time on it, we have not let that happen at the company. And we've had a strong, consistent dividend policy, and then we've done special dividends throughout the time. So therefore, past history is we have not let cash build. We've also spent money on acquisitions, and at the same time, those don't usually come around at the same time as not letting cash build, i.e. special dividends. So we look at it on a fragmented basis. And then in terms of share repurchases, we look at what we think is going to be the growth rate of the company and is it better for shareholders to buy shares -- is it better for the shareholders for us to buy shares from our view of our expected growth rates? And of course, we always have -- we have issued more shares, so there is some level that we'd kind of want to keep it going just to maintain the rate, even though -- the rate of shares outstanding. And of course, if you look at the past few years, we have continually reduced that rate of shares outstanding. So it's been a successful share repurchase program certainly in the last few years.

[Surinder Thind, analyst]

Got it. And then maybe one final question, a follow-up on some of the commentary or color around expenses. Obviously, you guys have been able to hold down expenses, but if we look past -- over the past few years, excluding distribution costs, even versus 3 years ago, you guys are down on what I'll call core expenses. And yet, when we look across -- and that's despite seeing really good, basically, growth within the long-term retail business in funds. But if we look industry-wide, it seems like expenses are generally up, and there's generally concern around making sure that there's investments in technology and a host of other things to try and even build out distribution. What's the difference with you guys in the sense that you guys have been able to kind of hold things flat? I know that, a few years ago, you're -- maybe expenses were elevated because of investing for money market reform and stuff, but I struggle to figure out why you should -- why you wouldn't see much higher expense growth going forward when everybody else is investing at this point.

[Thomas Donahue, executive]

So we are investing, too. It's the first thing. And the second thing is our expense profile is set up so much toward what I used to call success items. If we had -- if we did a deal, then our intangible expenses went up. Where we had sales, then our distribution expense went up. And then the opposite happens when we have money go out, then the distribution expense goes down. And also, the compensation incentive plans work that way, too, certainly, on the sales side. What's gone on in the last few years is, and when we say it kind of quickly, oh, a change in asset mix. Well, those are big changes on the expense side of things, and Ray has gone through some of those on the distribution side. But those are big impacts. We view -- we'll take the success that we manage expenses properly, but it's really set up to where we don't have to do anything. And it's a lot like the waiver program, where when the waivers -- we had to put the waivers on, well then, the expense went right down with it, and it looked like we were managing something. And we were because we had a deal with our customers on they were getting paid less and no one likes that, but it seems to work well. So that's my comment.

[Operator]

Our next question comes from the line of Kenneth Lee with RBC Capital Markets.

[Kenneth Lee, analyst]

Just want to have a follow-up on the money market fund seasonality. Great details on the separate account side, but wondering if you can give sort of like an expected seasonality in flows more in the mutual fund, money market fund side and maybe highlight some of the key factors that could potentially drive flows.

[Deborah A. Cunningham, executive]

Generally speaking, the first half of the year, the first quarter of the year are low in flows and are more on the negative side than on the positive side, and then that completely reverses in the second half of the year and particularly building towards the largest quarter, which is generally the fourth quarter. And again, I think, this year, the second half of the year will be amplified and probably maybe even bleed into the first half of the year from an uptick perspective just given where interest rates are at this point. 2% versus 0% is a heck of a lot different, and nobody is real concerned about regulatory reform anymore at this point. Maybe there's some shifts in their asset mix that they're looking to make. Maybe they're looking to diversify a little bit where their assets are. But for the most part, those that have assets in the liquidity space, and actually, those are likely to grow again, repatriation being something that we have out there as an unknown but likely a positive. We'll be trending, we believe, towards the sector that makes the most amount of sense in the current rate environment, which is the money fund side.

[Kenneth Lee, analyst]

Got you. And then a quick follow-up on H.R.2319. Just to clarify, would there be any kind of operational changes that will be required from clients to go back to amortized cost basis?

[Raymond Hanley, executive]

No. Because they're all in government funds right now. So it would just be another fund but with all the same accoutrements as going into a government fund.

[Kenneth Lee, analyst]

Got you. Very helpful. And then one final one just on the separate accounts, the fund vehicle. Presumably, lower fee than a mutual fund vehicle, but maybe you could perhaps remind us of the underlying economics, the differences between both of those vehicles for Federated.

[Thomas Donahue, executive]

Ken, the separate accounts are priced individually, and we went through that on other calls in terms of the factors that are taken into account, the type of money, the related services and all of that. So each account would be different there. We have talked about the state pool money in the past. Those contracts are out, are public record, and they end up at around 4 basis points of advisory fee. And then the funds, of course, vary all over the place.

[Operator]

Our final question today comes from the line of Patrick Davitt with Autonomous Research.

[M. Davitt, analyst]

You've had a couple of questions that suggested money fund outflows in January, but -- maybe I missed something, but I think you said the AUM was at $268 billion, which would suggest inflows.

[Raymond Hanley, executive]

Yes. The assets are up for the first couple of weeks of January, driven by the separate accounts. The fund assets are down a couple billion.

[M. Davitt, analyst]

Okay, got you. But net-net, you're still in inflow for the quarter?

[Raymond Hanley, executive]

Yes.

[Operator]

At this time, I will turn the floor back to Ray Hanley for closing remarks.

[Raymond Hanley, executive]

Well, that will conclude our call for today, and we thank you for joining us.