Federated Investors' CEO Discusses Q1 2011 Results - Earnings Call Transcript

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 |  About: Federated Investors Inc. (FII)
by: SA Transcripts

Federated Investors (NYSE:FII)

Q1 2011 Earnings Call

April 29, 2011 9:00 am ET

Executives

Ray Hanley - Analyst

Deborah Cunningham - Chief Investment Officer of Taxable Money Markets, Senior Vice President and Senior Portfolio Manager

John Donahue - Chief Executive Officer, President and Director

Thomas Donahue - Chief Financial Officer, Vice president, Treasurer, President of FII Holdings Inc and President of Federated Investors Management Company

Analysts

William Katz - Citigroup Inc

Craig Siegenthaler - Crédit Suisse AG

Michael Kim - Sandler O'Neill & Partners

Michael Carrier - Deutsche Bank AG

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Kenneth Worthington - JP Morgan Chase & Co

Marc Irizarry - Goldman Sachs Group Inc.

Roger Smith - Macquarie Research

Cynthia Mayer - BofA Merrill Lynch

Roger Freeman - Barclays Capital

Operator

Greetings, and welcome to the Federated Investors First Quarter 2011 Earnings Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Raymond J. Hanley, President of Federated Investors Management Co. Thank you, Mr. Hanley, you may begin.

Ray Hanley

Good morning, and welcome. Thank you for joining us. Today, the call will be led by Chris Donahue, Federated CEO; and Tom Donahue, Chief Financial Officer. And we also have Debbie Cunningham, who is Chief Investment Officer for Money Markets who will join us with some commentary on market activity and interest rate outlook and participate in our Q&A.

And by way of forward-looking statements, let me say that 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 our 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. And with that, I'll turn it over to Chris.

John Donahue

Thank you, Ray, and good morning. I will start with a brief review of Federated's recent business performance before turning the call over to Tom to discuss our financials. Looking at cash management. Money Markets average assets increased from the prior quarter for both our funds and our separate accounts. As mentioned in the last call, expected outflows early in Q1, mainly from flows that came in late in the year, led to lower period-end fund assets. Growth in average money fund assets was mainly from wealth management and trust channel, while Money Market's separate accounts growth reflected tax seasonality. While market conditions remained challenging, our cash management business is strong and stable, with our market share steady at around 8.8%. Debbie will comment later on the recent market conditions, which have further impacted yields and fee waivers, which Tom will also address.

On the regulatory front, money funds continue to be an active topic of discussion. Federated and others support the liquidity bank proposal advanced by the industry through the ICI. This enhancement would compliment that new liquidity provision of 2a-7 and would not socialize credit risk. We do not agree with suggestions that favor bank-wide regulation or bank-wide capital requirements, which in our view are far off the point and are more likely to do significant harm than enhance the resiliency of money funds, an important stated objective. In terms of the potential for a systemic risk designation, we don't believe that we will nor should be designated, and have submitted commentary in support for our opinions to the regulators.

Looking now at our Equity business. We are focused on a series of strategies that have solid performance characteristics and are well suited to meet the particular demands in the market. Leading in this area is strategic value dividend, a strategy that continues to produced strong flows and expanded distribution opportunities for both mutual funds and separate accounts. We added an international version of this strategy in mid-2008 and it has achieved strong one-year and quarterly results ranking in the top 3% of its peer group. The Clover Small Value strategy has solid 3 and 5-year results. This is an area that we see as good growth opportunity, in part because other successful products in this space in the marketplace have closed to new investors. At the other end of the cap spectrum, the costs in large cap funds also has a strong 3-year record and is garnering some solid flows. The International Leaders and InterContinental Funds had positive flows in Q1. InterContinental recently received the Lipper Fund Award for its category leading 10-year consistent return results. The Federated Emerging Market Debt Fund was also recognized as the leading fund on the same basis for its 3-year record.

While we usually direct our comments to longer-term performance records, with the difficulties that quant strategies across the industry including ours, experienced over the last couple of years, we did want to note that our MDT quant team had very strong performance in the first quarter. The primary strategy, all-cap core, brought its record to the top quartile for the one-year period, and had a top 1% ranking quarter for the first quarter. All 7 of the MDT managed accounts strategies beat their benchmarks in the first quarter, and 6 of 7 have outperformed since inception. Negative equity fund closed in Q1 and in the first couple of weeks of Q2, are due mainly to our alternative strategies, which are market ops and Prudent Bear, and to the Kaufmann fund. Looking at early Q1 results for the first -- I mean, early Q2 results for the first few weeks, equity fund flows have been modestly negative. As regards to Kaufmann Fund, one short comment, their approach continues to be the focus on high-quality growth company and to use of extensive proprietary research and a bottoms-up style, with high conviction and low turnover. It is very much a long-term approach.

Turning to the fixed income strategies. The Capital Preservation Fund led results for both gross and net sales, and I'll comment further on that shortly. High-yield funds and our strategic income blended product were among a series of funds that had positive flows. Our Total Return Bond Fund had outflows due mainly to the redemption we mentioned on our last call from a client who reached their maximum fund concentration level. We also saw outflows in municipal Bond Funds. We are continuing to look -- we are looking for good results from 2 recently launched products: our Unconstrained Bond Fund and our Floating Rate Strategic Income Fund. Bond Fund flows are negative in the first couple of weeks of April. The Uni Bond Funds continue to have net outflows. We have also seen some clients reducing their fixed income allocation as a part of re-risking strategies. This led to a few lumpy outflows in the first quarter and a $200 million redemption this month in Total Return Bond Fund.

Turning to fund performance. And looking at the quarter-end Lipper rankings where Federated's equity funds, 22% of the assets are rated in the first or second quartile over the last year, 16% over 3 years, 26% over 5 years and 84% over 10 years. For Bond Fund assets, the comparable first and second quarter percentages are 35%, 1 year; 51%, 3 years; 70% for 5 years; and 68% for 10 years. Looking at Morningstar-rated fund, 20% of the rated equity assets are in foreign 5-star product as of 3/31. And 2/3 are in 3, 4 and 5-star product. Interestingly, 96% of our international equity assets are in the top 2 quartiles for the first year, 1 year, and 21% for 3 years, 78% for 5 years and 78% also for 10 years. At quarter end, we had 11 equity funds with top quartile one-year performance including our strategic dividend, domestic and international, asset allocation, InterContinental and International Leaders Funds, along with several of the MDT funds. We also had 1/2 a dozen funds with top quartile 3-year records, and 9 funds with top 5-year records, plenty of excellent products that is selling in the marketplace.

As of April 27, our managed assets were $353 billion, including $268 billion in Money Market, $32 billion in equities, $53 billion in fixed income, which includes our liquidation portfolios. Money Market mutual fund assets stand at about $237 billion. So far in April, our money fund assets have ranged between $235 billion and $245 billion, and the average has been about $239 billion.

As regards to distribution, our Retirement business, which we have been investing in by adding sales staff in the DCIO area, is strong and growing. As mentioned, we added $1.2 billion into the capital preservation fund in Q1 by competing successfully in a high level RFP process with one of our major distributors. As a result, we have gained product position in about 700 new retirement plans, with an estimated 100,000 participants. We expect these assets to grow each quarter based on regular plan contributions, and we're also working to gain additional accounts and to grow the new accounts by adding new strategies into these plans. Excluding these conversions, we saw a 4% increase in Q1 to find contribution growth sales compared to the first quarter of 2010. Now generally across our channels, we see modest re-risking activity as our clients are looking to take on more risk. They're moving cautiously. In this environment, strategic value dividend offers a solid step-out strategy by providing equity exposure supported by a solid base of dividends.

Flow improvement in equity separate accounts was driven by higher sales of the strategic value dividend strategy and by lower redemptions in the MDT strategies. As a result, we saw positive flows in first quarter equity separate accounts after running negative in 2010. Fixed income separate account flows continued to be positive, and we see the potential for $500 million to $1 billion in new flows in this area over the next couple of quarters. We enhanced our product marketing effort in the first quarter with the launch of a campaign designed to initially promote the strategic value -- a strategy through a series of web and print ads. We also recently launched a redesigned website to showcase the insights of our investment professionals and better deliver product and market information and tools to our clients. Regarding acquisitions, we are focused on developing an alliance to further advance our business outside the United States. We are also actively seeking consolidation deals, and recently announced an agreement to transition $515 million from the equity trust funds in Q3. These were from FBL Financial Group in Iowa. Now obviously, we cannot predict the probability or timing of any other potential deals. But we are active in our analysis and focusing on developing further of these types of alliances. Now I would like to turn it over to Tom to discuss our financials.

Thomas Donahue

Thank you, Chris. Excluding the $0.11 of litigation settlement and related expense, EPS of $0.32 would have been $0.43. This expense was $18.2 million pretax, nearly all in professional service fees. Money fund yield waivers reduced pretax income by $13.1 million for the quarter compared to $12.1 million in the prior quarter. The line items impacted are covered in the press release. Based on current market conditions and asset levels, these waivers would reduce income by approximately $17.5 million in the second quarter. Lower short-term interest rates, in particular for a repurchase agreement, impacted these waivers so far in April. Looking forward, we estimate that gaining 10 basis points in gross yields will likely reduce the impact of these waivers by about 1/3 from the current level, and a 25-basis point increase would reduce the impact by about 2/3.

Looking at revenues, the decrease from the prior quarter was due mainly to 2 fewer days in the first quarter, which impacted the number by approximately $6.9 million, and to higher money fund yield waivers as average assets actually increased for Money Market equity and fixed income, while on liquidation portfolios decreased.

Turning to operating expenses. Compensation and related expenses in Q1 was in line with the estimate we gave last quarter. Q1 included a credit of approximately $2 million of prior-year incentive compensation. Distribution expense was down due mainly to higher money fund yield waivers and was also impacted by fewer days, which caused a reduction of approximately $2.5 million.

Looking at our balance sheet. Cash and marketable securities totaled $317 million at quarter end. This combined with expected additional cash flows from operations, and availability under present debt facilities provide debts with significant liquidity to be able to take advantage of acquisition opportunities, as well as the ability to fund related contingent payments, share repurchases dividends, new products, other investments, capital expenditures and debt repayments. We would now like to ask Debbie Cunningham to comment on Federated interest rate outlook. Debbie?

Deborah Cunningham

Thanks, Tom. Our interest rate outlook has actually not changed too much from the past 2 quarters. But it has been impacted in the short-term, fashioned by some of the regulatory changes that have just come into fruition. Namely for April 1 -- from the beginning of April 1, what we've seen on an FDIC assessment-based change is lower overnight set fund rates, which are the driver for lower overnight repo rates set in the marketplace. What has -- what essentially -- in 2010 was an average repo rate that was probably in the low to mid-20s. In the first quarter became somewhere in the neighborhood of the mid-to-high teens. And looking forward into the second quarter of 2011, it will be likely in the high single-digit area. As such, that will impact how the overall portfolios, to some degree, are aligned on a composition basis with less in the space that is required to -- that will be impacted by that overnight rate and the FDIC assessment changes. Having said that though, liquidity is the main characteristic of Money Market funds. And as such, we will continue to keep margin out in liquidity products going forward. So overnight rates are impacted in the first quarter slightly, but it will be more so in the second quarter by these FDIC charge assessments. On an outlook basis, however, for the overall curve for Money Market assets has actually seen a little bit of improvement. And a few more people that were in the rate-raising environment for 2013 and late 2012 have moved much closer to our end of the estimation, which is the end of 2011. We do believe, and obviously that was confirmed by Fed Chairman Bernanke, yes, earlier in the week that the overall queue-in-queue process will be completed. So we'll continue to see the purchase of treasury securities out of the marketplace to the level that was mentioned and for the amount of time that was mentioned. But soon that will change and it will be something that at the end of June, beginning of July, we're turning into something that is really an overall level that becomes much more characteristic of a rising-rate environment. So rising rates are what we would start to see and expect, and be it on QT, I'll call it quantitative tightening basis beginning in the third quarter. So we do think that the Fed will start on a reverse repo basis, putting some of their securities back out into the marketplace beginning in the third quarter and that will then lead to something that is eventual through tightening, ?[indiscernible] increase in the Fed funds rate by the end of the year of 2011.

John Donahue

Thank you, Debbie. We'd like now -- now like to open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from the line of Roger Freeman of Barclays Capital.

Roger Freeman - Barclays Capital

Actually Debbie, I just want to come back to the comments you were making just to sort of understand your thinking here. I guess it seemed to me that the message from the Fed this week was rates aren't going up and were basically holding the balance sheet fairly constant here. And I guess it sounds like you're suggesting the balance sheet is shrinking and that we do see if -- if I heard you correctly, we would see a Fed hike late this year. It seems like the market has actually been pushing that out, that fund future for December have actually come down quite a bit in terms of the likelihood of a rate hike. I'm just curious. It seems like there's a bit of a difference there.

Deborah Cunningham

Sure. And absolutely what we're -- we're convinced that the point is that the Fed is going to tread lightly on some of the market perspective. And Q2 is something -- well, to begin with, with something that was -- was and continues to be a grand experiment. And in the context of unwind that grand experiment will continue. Having said that, as market -- as a market that is starved for collateral, i.e. repo, FDIC changes, lower amounts of collateral available because much of it is sitting on the balance sheet of the Fed. The Fed will be encouraged as soon as their process is concluded on the purchase side of the equation. I believe they're set, they're ready to do the unwind portion of the -- from at least a temporary basis with the number of adversary co-counterparties that they have in the marketplace. Obviously they're not just talking about dealing with the primary dealers anymore. They've got -- I think at the end of the day, they're going to have somewhere around 80-some counterparties from a Money Market fund standpoint, and as such they have lots of capacity. And I think what they're going to find is there's a lot of demand for that collateral. So although it's temporary in nature, it's reverse repo. It's not actually putting those markets -- to putting those securities back out into the marketplace on a sale basis, on a profit sale basis. I do believe that they will head down the path of beginning that process. And once they do, they're going to find very happy recipients of it in the marketplace. And as such, that will encourage them to continue going. The other side of the equation from our perspective that leads us to still at end of the year 2011 is just to strengthen the economic picture that we've seen. Although GDP in the first quarter is going to be less than what have maybe been expected, slow growth is still something that from a Money Market perspective is almost nirvana. So we really think that slow growth and slow tightening process is something that will be well risky from the marketplace, certainly off the lows that we're in right now and have been for the last 2 1/2 years. I actually think that as it begins and as the Feds sees sort of the demand for it and the recipients in the marketplace being very positive, that leads us to the conclusion where we are, which is we think it will be in the second half of 2011.

Roger Freeman - Barclays Capital

Okay. That's helpful. And then just on the effective Fed funds rate, that is 9 basis points right now. Can you just kind of explain how the FDIC assessments are weighing on that? And then is that something that persists? And as you look at the upward bias to rates, that this is going to have some sort of a depressing impact or whatever that trajectory of increase at the front of the curve is going to be?

Deborah Cunningham

Sure. I mean, the FDIC assessment charges were something that -- they're in -- they're passing on April 1, everybody knew they were going to happen. The market was very wrong about what the impact would be. And the reason for that is the Fed in -- it isn't accepting changes. It's not really changing the amount of intakes, the amount of money that was coming into the FDIC fund, instead what they were doing was repositioning it so that more of it was being paid by larger banks and less by smaller banks. So the focus on the marketplace when looking at the impacts, last quarter basically and the quarter before that was on the big banks. So people are looking at JPMorgan, BofA, Citi and seeing what the impact on those banks would be in there, then -- therefore, that impacts on the marketplace. And that was sort of what was built into the expectation. What was really overworked and underestimated was the power of the smaller bank in this equation. Many, many smaller banks, tens of dozens of smaller banks who traditionally had put repo out in -- or put collateral out into the repo marketplace on a daily basis is keeping that supply at the level that it was decided that because of the assessment changes and the impact on their fee process, it no longer was a profitable thing. It couldn't even breakeven in doing that. So the immediate impact on April 1 was for a sizable amount, again on an individual bank-by-bank basis it wouldn't have made a hill of beans difference, but on a collective basis, the impact of the size of the withdrawal, pretty much collectively of those smaller banks from putting that collateral into the marketplace is what caused the rates to plummet. Now they plummeted too far, and what you essentially saw was something that was a retreat back to a fairly normal level. The foreign banks aren't affected by this, and yet they were being impacted in a very positive way because they were getting such great funding rates, so that has kind of leveled itself up back again. But what you're seeing on that Fed funds rate, 9 basis points is effectively what I was saying in my commentary earlier, that we had been in the low to mid-20s in most of 2010. First quarter we were in the mid-to-high teens and the expectation for this quarter is in the single digit -- the high single-digits area. Now there are 2 things that are exacerbating this, which could make it a little bit worse at this point. Number one is the balanced budget issue and the elimination of the supplementary financing bill, and the withdrawal of that collateral from the marketplace because of the debt ceiling and that potential for hitting that. So if those negotiations continue to go forward, and hopefully as they come to an end -- a successful end there is discussion about bringing that supplemental financing bill back into the marketplace, which would produce more supply, which would be a good thing which would cause rates to go up in that sector. The other side of the equation is queuing to itself. So that has a definitive end to it at the end of June. Once the Fed stops buying basically all the 2 to 10-year treasuries out of the marketplace and holding them on their balance sheet where we get no use of them, that will again create supply. But it is something that I'm looking as not a second quarter item. We're looking to those sort of exacerbation items not being corrected, if you will until the third quarter.

Operator

Our next question is from the line of Michael Kim with Sandler O'Neill.

Michael Kim - Sandler O'Neill & Partners

First, now that short-term rates have come in again more recently, just be curious to get your thoughts on kind of Money Market fund flows across the industry. And do you think we could see kind of a second wave of redemptions as investors maybe go back to bank deposit accounts? Or do you feel like most of that money has already left the fund at this point?

John Donahue

At this point, the rates that the customer was actually experienced haven't really changed all that much. So a lot of those funds were at 0 or 1 and have remained at that kind of a level. And if even before we're interested in higher rates, they have moved off. So we haven't seen a meaningful wave of departures that's why we go through the ranges and the averages of the assets that we're looking at. Now certainly, there's some amount of re-risking which we've alluded to, but it's really hard to detect in terms of a movement of these short-term rates.

Thomas Donahue

And Mike, just to add to that, the prime funds have not been impacted in the same way that Debbie mentioned by the -- in particular by the treasury situation. And so we have seen, during the quarter, some shifting actual increase in the prime fund assets, it's been more of a government fund impact. So there is -- remains federal yield prospects in the prime money funds.

Michael Kim - Sandler O'Neill & Partners

Got it. Okay. And then assuming short-term rates start to move higher at some point down the road, how do you see the dynamic playing out where maybe you have some institutional redemptions, just given kind of higher rates in the spot market, but at the same time maybe a step up in inflows from retail clients just given the higher yields? Kind of net-net, how would you expect that dynamic to play out?

John Donahue

Well, there will be less of each of those factors you just mentioned because of the reasons we just talked about, namely that those that were really driven or incented by whatever the yield was, have already made their moves. And so that's why we've been talking on the last several calls about a kind of leveling from our perspective in the assets of Money Market funds that we have. And you see it bouncing around a couple of billion dollar figure on a gross basis and on an average basis, and that's about as good as I could go in terms of a future look at things. Historically, the comments that we've made have been that throughout these cycles, we end up with higher highs and higher lows as we get through the cycles. And so far over the last several quarters including this one, we think that is playing out.

Michael Kim - Sandler O'Neill & Partners

Okay. And then just maybe a final question for Tom. If we kind of backed out the effects of the Money Market fund fee waivers, looks like your margins have been pretty consistently running in kind of the high-20%, low-30% range over last few years across what has been a pretty volatile period. So just looking ahead, is there anything out there that could meaningfully move the margin in either direction or is it mostly just kind of a function of mix at this point?

John Donahue

Did you say excluding the waivers?

Michael Kim - Sandler O'Neill & Partners

Yes.

Thomas Donahue

Yes, because obviously if the waivers come back, things could improve. But you've got to remember to go through, and we got revenue and then we pay out distribution fees, so what's the mix on that? But I don't see any dynamic to really answer your question on dynamic changes in the waivers situation. Some pretty obvious things if equity and fixed income increase.

Operator

Our next question is from the line of Michael Carrier with Deutsche Bank.

Michael Carrier - Deutsche Bank AG

Just on the equity side, it looks like separate accounts. You saw the improvement in the quarter. I think you mentioned the 2 big drivers would be the strategic value and then MDT redemptions declining. Yes, I guess within the separate account, any way to size those 2 impacts to the net flows? And then I guess just on the performance side, it just seems like on the equities, you gave 1, 3, 5, on average like only 25% or so the assets are out -- or the funds are outperforming. So just any issues there, anything that needs to be changed from like a personnel or is it just certain strategies under pressure but long term, either the 5 or the 10-year still looks pretty good?

John Donahue

Mike, just on the flow composition, the MDT strategies in total have about $3 billion of assets and about 2/3 of that would be -- actually more than 2/3 of it would be in separate accounts. And to be clear there, what we saw was a diminution in net redemptions in sequential quarters. So those products are still negative from a flow standpoint, but less so. And that improvement would have been around $125 million of improvement. The real story is the growth on the strategic value size and there the improvement in net flows would have been more like $250 million, maybe a little less than that. But we had, if not our best quarter ever, certainly one of the best in terms of both gross and net sales in that product. It's very well positioned in a number of high-quality SMA platforms, and it is clearly a strategy that's resonating with moderate re-risking activity that we see.

Thomas Donahue

And in terms of the second question. What drives those numbers in view of our size of $32 billion in equities and a $7-plus billion in the Kaufmann Fund. When the Kaufmann Fund assets move from one category to another, that really tilts those figures. And so that's one point. Now as regards to Kaufmann Fund on that point, we remain committed to the fact that this group is excellent investors in selecting good stocks over the long haul. The one fact I will give you that we’ve used with our independent directors and others is that there've been 22 rolling 3-year performance periods when since they started the fund. And of those 22 rolling 3-year periods, 14 of them have found the Kaufmann Fund in the first quartile while they've been in the fourth quartile 4 times, and in the third quartile, 3 times and almost never in the second quartile. And what's going on here is that this team is dedicated to finding stocks they believe in for the long haul. And it is also reminiscent of the time when we bought the fund in '01 coming off some relative tough performance in the late '90s and 2000. And they snapped back quickly after the '01 technology breakdown. So this is just the way that, that Kaufmann Fund does their investing and the way it impacts our overall performance profile. So we are certainly not looking at making any other changes there. One item that was announced early this morning was that we did have a change in senior portfolio manager as the Capital Appreciation Fund, with Jimmy Grefenstette joining Dean Kartsonas and now running that fund and that group into the future. And then the other factor which we mentioned is the MDT, and I don't have to repeat all of the articles you've read about what's happened to quant managers and the spring back that's happened so far this year that I went over in the remarks. So that's pretty much a quick synopsis on your second question.

Michael Carrier - Deutsche Bank AG

Okay. That makes sense. And just last one. When I look at the revenue change, and this is just sequentially, we just ?[indiscernible] the fewer days and in the waivers. And It looks like despite like the overall asset mix, being more favorable in terms of long-term versus Money Market, revenues were a bit lighter. So it looks like maybe within the long-term products, you have some shift going on in terms of different products, different fees. So I guess just in terms of like the fixed income complex, if you can give us an insight on short duration if you're getting inflows there, just what the fee rate on those products are for like versus the overall fixed income average. And then changing in equity just on something like Kaufmann or Prudent Bear where you see some more volatility versus the overall average? It’s just more helpful in terms of when we're looking forward, just what the -- where the fee rate's likely to head.

Ray Hanley

Sure, Mike. On composition, and the changes would've been very modest in terms of looking at the blended overall realization rates. But on fixed income, it would be reflective of some of the shorter duration products and also growth in separate accounts as the margin of separate accounts for both equity and fixed income would generate lower fees than the funds. On the equity side, I would agree with where the spirit of your question, across an array of equity products, the Kaufmann and the Prudent Bear would be higher than, say, average fees and so decreases there would impact the realization rate of it.

Operator

Our next question is from the line of Craig Siegenthaler of Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG

On the fee rate itself, just a follow-up on the last question, can you help us quantify what the change in either the fee rate was or the management fees were when you exclude the fee waiver? Because it looked like there was some deterioration in this quarter. I was just wondering if you could just add a little more color on that.

Ray Hanley

In terms of change from, say, the prior quarter and looking at advisory fees, it would've been about 1/2 of a basis point on equity and about 3/10 of a basis point on fixed income. So again the changes would've been very modest. And if you want to go through them further, we could probably do that offline more effectively.

Craig Siegenthaler - Crédit Suisse AG

All right. Perfect, Ray. And just kind of a follow up on capital management, how you're looking at it at this point with kind of your debt levels and your cash flow and your cash? How should we think you use these proceeds for?

Ray Hanley

Well, we continue -- as Chris mentioned, looking for acquisitions. So that's our number one objective. And of course, we're going to continue to pay dividends and look at buying the shares back. But we hope to use that in an acquisition.

Craig Siegenthaler - Crédit Suisse AG

Got it. So really no change there?

Ray Hanley

Okay.

Operator

Our next question is from the line of Ken Worthington, JPMorgan Chase.

Kenneth Worthington - JP Morgan Chase & Co

Sorry if you hit this, but on the expense side you're able to keep compensation and other expenses flat or lower year-over-year. And I guess my question is, can you continue to hold expenses in check for the rest of 2011? And particularly on compensation, what are the tactics you're using to really keep that from rising?

Ray Hanley

Well, a big portion of the comp is incentive-based and so we hope not to keep that in -- down because if it goes up, it will be because we've had excellent sales and better performance than what we're projecting in there to calculate out what that number -- what we expect it will be.

Kenneth Worthington - JP Morgan Chase & Co

So I'd like -- I'd sort of be polite, but if like -- is it basically flat because performance is down and the bonus pool was down? Is that what's going on?

Ray Hanley

Yes, when we do our calculations we look at -- I mean there's a lot of things, moving parts in there, but we have to make a forecast for the year what we think all the parts add up to be the total. And when it's -- when it’s the same as where it was last year's first quarter -- everything, although each one of them is different, kind of the same outlook.

Kenneth Worthington - JP Morgan Chase & Co

And then on the kind of a nonlegal-based, non-comp expense. Again same thing, it's like airline tickets are going up, so travel, I guess, would be getting more expensive and yet you're holding the line on these other costs as well. Possible that I kind of keep holding the line?

Thomas Donahue

We worked very diligent to manage things effectively on a cost basis. We recognize the waiver situation that's going on and how it's affecting us and are trying to react to that where we can, yet still allowing proper sales efforts and proper distribution and investing in the company.

Kenneth Worthington - JP Morgan Chase & Co

All right. And then just a modeling question. How is the Money Market fee waiver revenue impact a 63.4 split between investment advisory and other service fees?

Thomas Donahue

The splits, Ken, was $36 million advisory fee and $27.5 million of other service fee.

Operator

Our next question is coming from the line of Roger Smith of Macquarie Bank.

Roger Smith - Macquarie Research

I wanted to talk a little bit about the systemic risk. Can you tell us how you're participating in these discussions and determining what is systematically important and to be -- like is that directly or are you basically utilizing the ICI or some other type of lobbying group to make your point about money markets not being a systemically important entity?

John Donahue

Roger, this is more or less an across-the-board exercise by us. It involves me, it involves other senior executives as Federated personally making pitches to the SEC, to the FDIC. Then it also involves participating on the committees and with the ICI. It also involves writing extensive commentary letters, which I think have been well respected and well received, demonstrating our views that the criteria that have been established for designation are simply not applicable and really not met by Money Market funds specifically, or mutual funds in general. And it's primarily because none of these enterprises are on leverage. There other reasons as well. So if you check the records down in Washington, you'll see us showing up periodically making this case because it's very important to us and to our investors.

Roger Smith - Macquarie Research

Great. And then I know it's still early, but can you give us any kind of sense in how the sentiment of the view from the regulators is changing? Would you say that as you make this lobbying effort that you get the sense that they agree with you? Or are they not holding a poker face and you can't really tell? Or is there any kind of change that you can give us some idea about?

John Donahue

I would say your characterization of poker face is the end result. The cordiality, respect and honest discussions, though, have been what we have experienced. I think you can see in the press as well as anybody that there’re certain of the people who are on FSOC who want to designate a lot, and then the treasury and the Fed basically saying designate a few. And there were a number of speeches within the last weeks on those subjects. Our own view is that if they designate anybody, it will be a very, very few. And we don't think they will designate any Money Market funds or mutual funds, but we don't control it and I wish I could say that all of our efforts -- you could reflect and say, "Oh well, boy, we really won that one." But that's just not the way this works. So we make our pitches. We repeat the sounding joy. We write it out in detail, and we expect that the proper result will follow.

Roger Smith - Macquarie Research

Great. And this is my last question on this topic. Is there any change in the argument by the people that want more systemic designations around the Money Markets, or has the argument been the same all along? Is there any change on why they believe this business might be more systemically important?

John Donahue

No, there have been no new arguments. It's like old friends. And we look at it and say, "Yes, there was a challenge in the money market fund industry when reserves broke the buck." And that was addressed by the Treasury, by the Fed with these liquidity features and by the SEC in how we did the Putnam transaction. And how we did the Putnam transaction was basically infused into 2a-7 to make an industry solution that did not require federal money. The liquidity bank that we have spoken of and I referred to in my remarks, addressed the liquidity that was a private liquidity system that was requested by the President's Working Group. And so, we think that, that addresses all the issues, but that hasn't -- that really hasn't changed as the basic arguments.

Roger Smith - Macquarie Research

Okay. Great. And then I just have one last question on the Fixed Income Mutual Fund business. Can you give us an idea of what products -- and I might have missed this, what products are actually gaining the traction? Because, I'll tell you, from the industry data that we get, I would not have thought it would have been as good as it came out this quarter.

John Donahue

Well, Roger, we've seen interest in high-yield products and the short duration has had some slows as well. On the alter short side, we talk about outflows on the muni side and somewhat surprisingly, there's been -- the muni alter short fund has had outflows that, given its placement, we feel like that just kind of get swept up into the general market sentiment about munis. So it's still been the short duration, the high yield and certain of the blended products. Even as our, for example, the total returns fund that we mentioned has had a few of the lumpy outflows where people have done reallocation. There continues to be a strong level of sales and other people entering into the product.

Operator

Our next question is from the line of Robert Lee of Keefe, Bruyette & Woods.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Maybe follow-up question on capital management. If I think back to your first special dividend 2-plus years ago, it took down some leverage under the special dividend, paid down debt for kind of the next 5, 6 quarters or so, announced another special dividend, took down some debt. And now here we are about 5, 6 quarters later, you've been amortizing down some debt. Is it reasonable to assume that as we get the latter part of this year that you're thinking about a special dividend to pick up?

Thomas Donahue

Well, Rob, the way I'd answer is exactly how I answered the last question on that. Our first choice is to look to grow through acquisitions and on the international side. Gordy Ceresino is out traveling around, searching. But to come back to specifically your question, we look at what are we going to do with our capital and have made those decisions like you pointed out at various times. And if you want to call it eclectic, we're always looking or trying to look for what's in the best interest of our shareholders, and how to get them the best return. And we paid 2 special dividends and thought that, that was the proper thing to do for our shareholders. We could come to that conclusion again.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Okay, fair enough. And maybe a question for Chris. Can you maybe just update us on -- you talked a little bit on the call about your efforts in the DCIO market, but maybe update us on some of your efforts through, I guess I'll call it more traditional or other distribution channels. I mean, are you -- are there any particular platforms or places where you think you feel like you've had more success getting more products on the shelf? I know for a long time you spoke about Jones, but I guess you haven't talked about that in a while, but maybe just update us on kind of how you think your positioning is and some of the noted key -- other key distribution platforms and where some of your initiatives are to maybe improve it.

John Donahue

One of the biggest ones we already mentioned, which was the $1.2 billion in capital preservation. And that was with a major -- one of these major distributors. And when you're looking at 700 new plans and 100,000 new participants, that's a pretty good step up in basically what's available. And I think what we're looking at here is opportunities in the broker-dealers space that increased number of our salespeople who are actually able to get their clients, meaning the intervening broker-dealers to write $100,000 tickets. And then another way to express that is doing more than just one particular mandate, but doing 2 or 3. And right now, we're looking at an examination of the sales force to see how we can expand that a little bit to make that more possible. And it's because some of the successes we've had. If you look at our equity sales, they're running comfortably above 500 a month on average. And back in '08 and '07, they were in the low 400s a month. So we're looking at that as a pretty good situation. The new products that we've come out with have also give us some enthusiasm. The results to the low duration product and the end constrained bond funds have been pretty good, and that's why we've opened up an advertising campaign. If you check in your investment news or your Barron's, you'll start seeing ads from Federated which you hadn't seen for a while and that's all part of the effort.

Operator

Our next question is coming from the line of William Katz of Citigroup

William Katz - Citigroup Inc

A couple of questions here. Just on the fee waiver discussion, you've been very optimistic about rates for a bit of time and advantaged have been wrong for bit of time as well. Any thoughts of hedging the risk at this point in time if you're wrong and rates and policy tends to be a little looser than you anticipate?

Ray Hanley

No. No.

William Katz - Citigroup Inc

Okay, second question is as the discussion here about the top line seems to be somewhat cautious in my view, just given the adverse mix shift and the lack of really unique growth for the company. Is there a chance there you might have the opportunity to take out expenses if the top line earnings power continues to be an issue?

Ray Hanley

Well, from my look at it, we spent the last couple of years when the market was challenging to deal with -- a lot of expenses in the company that didn't go far to cut into the core of things and we're investing and continuing to divesting in like the new products that we've done. And technologies and websites and things that we need to be prepared for when the market comes back stronger and when we come back stronger. So my look at it is, we're sitting here with a pretty good expense profile and ready to reap the benefits of growth.

William Katz - Citigroup Inc

Okay. And just my last topic, it's just around capital. I was just curious if you could talk about -- you've been mentioning non-US prop, you have for a bit of time as well. Just sort of wondering what might be the holdup at this point in time, is it pricing, is it the right fit, is it just sort of -- is it just where are you still looking in terms of geographic? And then separately, how might you finance that? And I asked that question in that if there's no deal and you want to contemplate a special dividend by levering the balance sheet, is that something that you’re willing to strategically risk in light of just the ongoing regulatory, I'm sorry, you ran both the Money Market business and systematic risks. Thanks.

John Donahue

Bill, I'll talk about the international acquisition ideas and Tom will talk about the financing there. The concept of holdup isn't exactly how I would describe what's going on there. What we have discovered, no surprise to us really is that it takes a long time to develop good relationships, to be in the right spot at the right time, to do a deal that is a cultural fit that meets our criteria. So this is not just a power shopping deal where we want to get something checked off. We want to look and get something that is going to really work for the long term. And that has proven more challenging than perhaps we had thought going in. But the pattern of it is very similar, and the attitude we have is very similar to that which we had domestically. So we continue to look for it. And I don't think that it -- in the list of things that you mentioned like, "Oh is it pricing? No, this isn't pricing." It's finding the right group with the right culture. And I don't think even when we get there, that the pricing will really be the issue. Nor do I think it will be the financing, which Tom can talk about.

Thomas Donahue

All right Bill, a year ago we took out our $425 million loan from the bank, 5-year deal. And what we said at the time was we're raising that, we like where our rates were and we wanted to have the capital. We did not -- we have pretty significant amount of the dollars that we raised still on our balance sheet and invested through CD and other investments. And I went through with Rob what would we consider a dividend or share buybacks or acquisitions. And our answer to those are yes. It doesn't mean that we have a plan to change the fact that we wanted to raise money for what I called risk management to have the capital here. It was not fun to go through those couple of years and try to talk about borrowing. And so to have it already borrowed, as a finance guy, to have the money available for what our business people want to do is part of what I view my job is. So if we do come to conclusion to use up a lot of that, I would still want to have the view that we have capital available to do the things that we want to do to grow the company.

Operator

Our next question is from the line of Cynthia Mayer of Bank of America

Cynthia Mayer - BofA Merrill Lynch

Just coming back to the issue of expense control, if it's not too much. Clearly, it's been really strong for this side from that variable comp, which I guess is influenced by other things like performance. Is it possible that when fee waivers begin to come off, you'll ramp up some of the controllable expenses? Are the projects you've deferred which you think you'll need to accelerate? In other words, how should we think about the returning revenue? And how much of it drops to the bottom line other than the distribution offset?

Thomas Donahue

Yes, just let me go to the distribution. And you can do your tax rate and your margins on that and figure it out pretty readily.

Cynthia Mayer - BofA Merrill Lynch

Yes, other than the distribution, are there other things that are sort of pent-up that you will need to fund.

Thomas Donahue

Yes, Cynthia, we have a technology committee that goes through and gets back enormous technology requests and we go through a prioritization and processing and have actually the business people in each group determine their own priority, and then if there's a real problem we send -- we have the tech committee decide what we're going to do. And there is always -- and there has always been pent-up demand there. You follow the systems in communications line, we haven't really cut that. And we continue to invest in there, we think it's just -- it has the right feel to it if we had absolute demands where we had to get stuff done, and we would either cut something out as we -- that's how we've done it -- or not cut it out, but delay it until the next time around. So I don't feel like there's a big time pent up demand of things that we haven't done. And I don't expect it -- the waivers come back and we'll have any kind of explosion on expenses. We are, as Ray mentioned, we're testing -- or Chris mentioned, we're testing out some advertising on a dividend strategy fund and if that works well, we could do more of that. So that could be an area that would increase. And we hope we'd match that up increase because we saw successes with it.

John Donahue

Cynthia, I would like to add a little bit. Regardless of the margin -- of the waiver moves in this first quarter we did have a modest expansion in some of our institutional sales efforts. We've hired 2 of the 3 that we wanted to add. And this is basically calling on the research gatekeepers, the consultants, which kind of allows the sales reps to focus on the sponsors and then these guys focus on the consultants, and that kind of a deal. So there will be isolated efforts on the distribution side where we think we can expand. And to us, there are some quote, pent-up needs like I was talking about in response to some earlier questions. In terms of other distribution opportunities that we may see. But it isn't like, oh well, we had deferred maintenance or something like that.

Cynthia Mayer - BofA Merrill Lynch

Great. That's helpful. And then some modeling question. It looks like the tax rate was a bit lower this quarter, but I wasn't sure because of the one-time expense. But what kind of tax rate are you expecting?

Ray Hanley

We really haven't changed there, Cynthia. It was pretty much right on 37%. And we've said 37% to 38% that we'd kind of hold in that range.

Cynthia Mayer - BofA Merrill Lynch

Okay. And then, just to clarify on the fixed income flows. It sounds like you're having outflows from the fixed income funds, but you're expecting good inflows with the separate accounts. And is that difference just because the separate accounts are more weighted toward strategic value?

John Donahue

Strategic value is leading the pack there. But it isn't the -- that isn't the only area.

Ray Hanley

The product mix is much different, Cynthia, in terms of funds and separate accounts. So the biggest thing you would point to as strategic value would have a higher weighting relative to other strategies in the separate accounts as compared to the funds.

Cynthia Mayer - BofA Merrill Lynch

Okay. Great. And then lastly just circling back to the regulatory questions. What sort of mileposts are coming up that we should be looking for? And what kind of timing are you expecting?

Thomas Donahue

I wish I would know the mileposts. I do not. And I can't say exactly what we'd have. I heard rumors that they'll do some designations maybe in the summer, but I don't have a firm understanding of exactly what the timeframes will be.

Operator

Our next question is from the line of Roger Freeman of Barclay's Capital

Roger Freeman - Barclays Capital

Just a couple of follow-ups. Actually just on the regulation, Chris, I mean I guess on milestones it looks like at least not as far as the potential liquidity bullets that the SEC is doing a round table here soon, May 10. And then ICIs got a big summit coming up on the 16th. I guess on that topic, I mean, how do you -- is the most likely outcome maybe -- or can you weight the outcome between having a liquidity full and ultimately nothing. And separately, whether the whole designation issue factors in here i.e., is there sort of more push for this if there a Money Market funds that are designated systemically important versus not?

John Donahue

Well, as I told you, I don't think they're going to designate any money market funds. And it's very difficult for me to hypothesize or make book on what comes out of these sessions. I mean, we've had a lot of study at the President's Working Group, the responses. And there are some good people going to be testifying. I read the drafts of the testimonies for these meetings that you're coming up. And I think we made some outstanding points consistent with what I've said here before. So all of this information, it doesn't change where I think it comes out. But again, I don't control the outcome and obviously, we're our big Money Market fund providers, and so we think we have this thing pretty well wrapped and understood. So I would hope and expect that they do the liquidity bank. But I can say that they will.

Roger Freeman - Barclays Capital

if they do that, I guess the proposal is that that'll get built up through payments that you and others make into it and likely pass on through fees to the end customer. But given the economics in a Money Market business right now, depending on how long that ends up running, I mean is that even something that could be passed through or is that something that firms like yours have to absorb?

John Donahue

Well, when you say pass-through, the structure of it is that the advisor would put in, in our case I guess, about $17 million to start with and that can't be passed through because there's no mechanism for passing through. And then the funds themselves would put some number of basis points in, which comes out of the yield. And there you have to be careful to maintain the proper spread between government funds, agency funds and prime funds. If at the end of the day you really want to have corporate issues to be able to issue commercial paper and have Money Market funds participate in that, in other words enhance resiliency of money funds. So there's no way to recapture any kind of money. Now today when there's hardly any yield available, yes, that makes all of these things little more problematic. But getting them in at this point is probably a worthy idea because in it gives you time to get the structure set up for when the rates eventually do go up. And we're talking about long-term solutions and long-term responses, much the same as we did when we were enthusiastic about the changes to 2a-7, because we're in this business for the long haul and our clients have demonstrated overwhelmingly that they're in the funds for the long haul.

Roger Freeman - Barclays Capital

Okay, that's helpful. And then just, Chris, the worst -- as you kind of kind of look at that step down there, the incrementally worse economics around the Money Markets at present, do you think that changes the decision tree at all with the skilled players that might accelerate anymore to want to get out of this business?

John Donahue

As we said before in this, Roger, if an individual group controls the redemption where the right to redeem or knows the people who can control the right to redeem and can influence them, then you can run a Money Market fund for a long time. But I think every one of these moves just adds to the burden that money funds have to carry. And therefore, like it or not, enhances the oligopolization of the business. But it never does it in such a way that it creates an avalanche or a cliff were all of a sudden, oh well, now everyone has to go do something. It hasn't happened in that yet and I don't think that's the way it will go. But there are a steady stream of people, we're talking to some now, who are looking to exit the Money Fund business and I think it'll just be a continuing effort.

Roger Smith - Macquarie Research

Okay. Last question. Coming to your -- back to your comments around some re-risking on the part of investor base, I'm looking at the Prudent Bear fund actually looks like it's kind of better flows, at least March looks like it's actually positive. Does that suggest at all any increase in risk aversion?

John Donahue

The Prudent Bear fund is a unique fund. And it is best sold when it is sold as a 5% or 10% part, permanent part, long-term part of an existing portfolio. And to-date, a lot of people tend to use that fund with higher percentages or bigger amounts based on where they think -- or where they think the market is going or where it has just been. And so, it's pretty difficult to make a direct assessment to re-risking from the flows on the Pru Bear fund. If you just -- it's just tough to do it now. We make those judgments more based on the commentary of the sales force, backed up by flows in some of the other products and talking to the sales leadership and the sales individuals that rather than specialty the those on Prudent Bear.

Operator

Our last question is from the line of Marc Irizarry with Goldman Sachs

Marc Irizarry - Goldman Sachs Group Inc.

On the fee waivers. If I look at the sequential change in operating income relative to the sequential change in revenue, it looks like the dynamics -- I'm trying to understand the dynamics there of the operating income delta versus the change in the fee waiver revenue? And how does that relate to the 33% uptick in the fee rate sequentially?

Thomas Donahue

You mean just go through the numbers in the press release where -- are you asking how much of this impact is from the waiver? Or how much is from everything else? I don't follow your question.

Marc Irizarry - Goldman Sachs Group Inc.

So, yes. The question is when you think about the seventh, the guidance on the fee waiver's moving up, is there a change in -- or what's accounting for the change in the operating income delta versus the change in the fee waiver revenue, some sort of that margin or the operating income loss per dollar of lost fee waiver revenue. Are you sharing more the burden with the channel? Is there a mixed shift that's impacting it?

Thomas Donahue

Okay. The repo rate that are down are exactly what's calling it, and we're either sharing it with the channel just as always. It's lower rates and we're sharing like Chris said earlier that the customer's not really having too much of an impact. It's impacting us.

Marc Irizarry - Goldman Sachs Group Inc.

Okay. And your share of that share, so to speak, that's not changing?

Thomas Donahue

No. I mean, it's moved around a little bit, Marc, but within a relatively narrow bandwidth and plus or minus around 75%, depending on the mix of the product, but we haven't seen any significant change there.

Operator

There are no further questions at this time. I would like to turn the floor back to management for closing comments.

John Donahue

Well that concludes our call and we thank you for joining us today.

Operator

You may now disconnect your lines at this time. Thank you very much for your participation.

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