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It's been a rough six years for Mark Fetting, and he's only been CEO for four of them. When the 57-year-old took the reins of Baltimore-based Legg Mason in January 2008, he knew he was inheriting a handful of not-insignificant problems stemming from swallowing a difficult acquisition, the faltering of a high-profile fund, and a cultural transition from the only CEO the firm had ever known. That handful of problems, however, has grown into what many see as an intractable morass of issues. Among them: massive outflows, poor investment performance, and a clumsy corporate structure, all amidst a rapidly changing industry.
Mark Fetting is not the name that jumps to mind when Legg Mason (ticker: LM) is mentioned. That honor goes to famed, legendary, veteran -- you pick the adjective -- Bill Miller, manager of Legg Mason Capital Management Value Trust (LMVTX), itself a household name.
But Legg Mason is parent to several highly regarded boutique fund firms. Institutional investors know that Western Asset Management is part of the fixed-income triumvirate, along with Pimco and BlackRock. Legg also owns Royce Funds, one of the industry's most experienced small-company stockpickers, seasoned dividend and income investors ClearBridge Advisors, and Permal, a pioneer in funds of hedge funds. Decades of terrific performance across the board led to a rising stock price, more acquisitions, and, ultimately, $1 trillion in assets under management. But Legg has fallen faster and harder than most asset managers in recent years, and its stock and fund shareholders have suffered.
April 1 marked the start of the firm's new fiscal year, and heralded a slew of new questions surrounding the firm's ability to turn around. At $26.85, the stock is a long way from its high of $136 in 2006 -- the year in which everything started heading south. Since then, Fetting, who joined Legg in 2000 to manage the mutual-fund business and aid in strategic planning, has struggled to reverse withdrawals, improve performance, shore up the money-fund business, streamline the corporate structure and return the firm to profitability. He's accomplished some of that; the firm is expected to report earnings of $218 million, or $1.45 a share, on revenue of $2.66 billion for the just-ended 2012 fiscal year. That's up from a $1.95 billion loss in fiscal 2009, which sent the shares down to $11.
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Legg Mason CEO Mark Fetting
It hasn't been an easy task. Fetting cut $140 million in costs and about a third of Legg's corporate employees, implemented a $1 billion share-buyback program and reorganized and streamlined the executive offices. "At this point, it's a lot of blocking and tackling," says Rob Lee, an analyst at Keefe, Bruyette & Woods. "There are a lot of challenges in a decentralized business model."
In other words, Fetting has pulled most of the levers at his disposal at the corporate level, but there's work to be done at the affiliates. "It's not an issue of the model," Fetting says. "It's an issue of us delivering on our plans. We have what it takes to complete this turnaround." But he couldn't help bristling, "I'm not sure how constructive it is to dwell on the past."
But that's exactly what investors are doing -- and will likely continue to do -- until the company's three-year investment performance starts to outshine its peers' and the results of Fetting's restructuring plan begin to bear fruit. The CEO insists that the latter will soon be apparent, calling the period just ended a "good, clean quarter."
Fetting has had some high-profile help. Nelson Peltz, founder and manager of hedge fund Trian Partners, started buying shares in 2009 and soon secured a seat on the board. Peltz is known for working closely with management to lower costs, and most agree he's been the force behind much of Legg's recent streamlining. He's agreed to limit his stake (currently 10.5%), preventing him from forming partnerships to amass more voting interests or forcing a sale or merger of any of Legg's affiliates. That agreement, however, will stay in effect only until November. Peltz declined to comment for this story.
A vocal advocate of returning capital to shareholders, Peltz has added a level of urgency to Legg's turnaround efforts. But there's no magic wand that can instantly restore assets to the trillion-dollar mark or erase the most egregious problems of recent years.
AFTER MERGING HIS SMALL BROKERAGE FIRM, Mason & Co., with regional broker Legg & Co. in 1970, Raymond "Chip" Mason, spent nearly four decades building the asset-management side of the business. Legg Mason is largely a product of good times -- and simpler times. "This business is all about performance, and we had outstanding performance," Mason, says. "When you have good performance, it's amazing how many other things work." The problem Legg Mason now faces is the corollary: When performance suffers, problems that were minor or easy to ignore in good times can become huge issues.
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Western Asset Management CEO Jim Hirschmann
Mason was also the architect of the firm's largest acquisition, swapping Legg Mason's brokerage business for Citigroup's $460 billion asset-management unit in a $3.7 billion deal that made Legg the country's fifth-largest asset manager. Citi's bond and money-market funds were folded into Western, while its stock funds were organized into a new unit called ClearBridge Advisors.
It wasn't long before trouble in Citi's money funds became trouble for the firm. The funds had invested as much as $10 billion in structured investment vehicles, or SIVs, that plunged as investors shunned mortgage-linked debt. To increase liquidity, Legg Mason sold $1.25 billion in convertible notes to New York-based private-equity firm KKR in January 2008. The debt, which comes due in 2015, is convertible to stock at $88. With that share price a sheer fantasy right now, KKR has had to be satisfied with a 2.5% yield and a seat on the board. KKR didn't return calls for comment.
Around the same time, Bill Miller, best known for his 15-year streak of beating the market, lost his mojo. All of it. After besting the Standard & Poor's 500 every year from 1991 to 2005, in 2006 the fund turned in a gain of 5.9%, far short of the S&P's 15.8% gain. By 2007, Value Trust had fallen so much it landed at the absolute bottom of its peer group -- and it remained there in 2008.
Meanwhile, Western was having more than just money-fund trouble. The firm, known for its prowess in times when riskier assets do well, suffered when it bet that Treasury bonds wouldn't rise (they did -- a lot) and generally took on too much risk for virtually no reward.
In the midst of all this, Mason, now 75, was 68 and looking forward to retiring. "As CEO, you really need to be pounding the pavement everywhere, especially Asia and the Middle East," Mason says. "I used to love it, but the desire to always be on the road definitely wanes."
Mason tapped Jim Hirschmann, the CEO of Western Asset Management, as his successor. But after taking the title of Legg Mason president and chief operating officer for a year, Hirschmann and his family were unwilling to move across the country for the post. "At that point, I had a daughter entering high school, and I agreed to do it if I could commute for four years," Hirschmann says. "But it became clear that to be effective I needed to be there all the time, and I wasn't willing to move and have my daughter blame me for ruining her life." And so began a six-month search for the next CEO, ending when Fetting was chosen.
TENSIONS ARE HIGH at Legg. And no matter how far-flung or independent the affiliates are, it's clear everyone is weary of talking about what went wrong, and reticent about discussing relationships with the parent company -- at times to the point of obfuscation. By and large, the fund families that Legg Mason owns are still premium brands that are struggling, but shouldn't be written off. The CEOs are frank in discussing their firms, but as soon as the conversation turns to the parent company, words are chosen much more carefully, body language becomes awkward, and faces go poker.
Legg's investors aren't much more helpful; the largest shareholders would speak only off the record, and some not at all. Many are hedge funds specializing in turnarounds and prefer to keep quiet; others are competitors who find it unseemly to discuss their peers. A less tangible reason is that investors are disappointed in Legg, and not in a strictly financial sense. It's like watching people you respect make a series of bad choices and not quite understanding how they're going to pull themselves out -- or how you would, in their situation.
Legg is a tricky company to parse. The firm doesn't disclose its revenue-sharing agreements with the affiliates, though most analysts and investors estimate that it takes 40% of their revenue. Western, by far the largest of the affiliates, is the biggest contributor to both revenue and profit. But Permal and Royce, though a fraction of the assets, vie for second place as profit contributors. Overall, equities make up just 25% of Legg's assets but comprise 44% of revenue.
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Sam Peters, manager of Legg Mason Capital Management Value Trust
Legg should get a boost if and when interest rates rise. While only 6% of its revenue, money funds represent more than $100 billion in assets. Though Fetting says they aren't losing money on the funds, the firm is waiving $100 million in fees annually. Even a half-percentage-point rise in rates, he says, would make them profitable again. Analysts say that it would have to be a full point increase to have a meaningful impact on profitability.
Organic growth is the next big question. The firm is looking to make small, targeted acquisitions, primarily to boost its international offerings. But Legg suffers from sitting out of two of the largest asset-gathering trends -- 401(k) platforms and exchange-traded funds.
Fetting says he has no intention of purchasing a record-keeping business that would enable the company to get into the 401(k) space. And while he acknowledges that the index-ETF business is saturated, Legg has filed with the SEC for several actively managed funds.
The news isn't all bad. Legg trades at a lower multiple than its rivals, about 13 times next year's earnings. Most analysts think the stock can hit $30 or so in the next year, a better-than-10% increase. A renewed commitment to buying back shares, which Fetting hinted at, could help, but ultimately analysts and investors agree, it's primarily about performance. And that's up to the affiliates.
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You can't talk about Legg Mason without talking about Legg Mason Capital Management -- even though with $8 billion under management, LMCM represents about 1% of Legg's total assets. That wasn't always the case. Bill Miller's management of Value Trust kept the firm in headlines and, for decades, flush with inflows. For years, the headlines were all about Miller's prowess, and the fund's assets reached $21 billion in 2007. Today's headlines aren't nearly so kind. Thanks to big bets on financial stocks and the resulting outflows, the fund has fallen to just $2.5 billion. Miller, 62, is three weeks away from leaving the fund in the hands of Sam Peters, who was hired in 2005 and named Miller's co-manager and successor in 2010.
Peters has already made some changes. He's increased the average size of the company in the portfolio to $100 billion from $60 billion, and he isn't inclined to have any one stock make up more than 5% of the holdings. He's most interested in the technology and health-care sectors, both of which he says are "priced for zero or negative growth." Apple (AAPL) is his largest company, at just under 4% of the portfolio.
Peters is charmingly wonky and self-effacing. He gets excited when talking about "beta infection" and owners' yield. He invests with an eye toward a three-year horizon, but acknowledges that the pressures of money management today and his situation in particular force him to keep close watch on the short-term results. "When I was first named co-manager, Chip told me that 'all that long-term stuff is great, but you don't have forever,' " Peters recalls with a laugh. "Two weeks later, Mark Fetting told me the same thing."
Miller will stay on to manage the even-more-decimated Legg Mason Capital Management Opportunity Trust (LGOAX), a mid-cap value fund with $1 billion in assets that trailed the S&P 500 by 37 percentage points last year, putting it at the absolute bottom of its category. This historically volatile fund has bounced back this year, and is now beating the S&P by 13 percentage points. While it's hard to recommend this fund, it's also hard to count Miller out completely. One theory posed by someone speaking off the record is that the money in this fund is largely employee money -- explaining Miller's determination to stick with it.
CEO Jim Hirschmann and chief investment officer Steve Walsh have told this story before. While most money managers have become practiced at shrugging off the financial crisis as something no one saw coming and no one could have done anything about, Hirschmann and Walsh are refreshingly frank about what went wrong and, more importantly, what they've done to address systemic weaknesses.
The giant among the Legg Mason affiliates, with $442 billion in assets, Western is best known for investing in virtually everything but Treasury bonds -- including corporate, high-yield and sovereign bonds, as well as mortgaged-backed securities and other more complicated products. That risk usually leads to higher yields, but the firm underestimated both the total risk it was taking on in early 2007, or how quickly and pervasively investors would cling to the safety of government bonds.
"We saw the Federal Reserve lowering rates and beginning liquidity programs in late 2007, and thought, okay, they're on the case, things are going to start to turn," Walsh says. "We didn't see that the real crisis was still on the horizon." Another problem was an over-investment in the financial sector. "We went through a pretty serious and critical self-assessment," Hirschmann says, which included hiring an outside consulting group.
Western made several changes: It hired Ken Winston, who oversees firm-wide risk, including investment risk, rather than have each manager simply evaluating the risk in his or her own portfolio. Those managers also meet much more regularly, and share a "risk dashboard," a one-page document that presents the risk taken on throughout the firm in a common language and format.
Performance has turned around, and given that Western's worst year was 2007, it won't be long before the firm's five-year numbers look better. And as pensions and other institutions crave more yield, Morningstar analyst Greggory Warren says, they will turn to specialized Western products that are more lucrative than some of the core accounts.
Western is also making a bigger push into the retail space. In May, the firm will announce retail share classes of its institutional funds. Eventually, Hirschmann says, he'd like to see other Legg fixed-income funds either folded into Western's, or branded as Western.
The modern midtown Manhattan offices of Permal house one of Legg's newer and lesser-known affiliates. But it's a powerhouse financially. Permal offers 18 funds of hedge funds, which make up about 75% of its $18 billion in assets; the remainder is in separately managed accounts. Despite the fact that it's a fraction of Western's size, its hedge-fund fees are the highest of all the affiliates' by a substantial margin, making Permal frequently the second-largest contributor to Legg's profits.
The firm chooses the best hedge-fund managers in a particular style -- such as global macro, equity long/short, fixed-income hedge, natural resources and event-driven -- to include in its funds. The Bernie Madoff scandal highlighted the problems of funds of funds, which funnel more money into hedge funds than the individual funds would see if people and institutions invested directly.
But Permal analysts examine and choose some 200 hedge-fund managers to invest with at any given time, out of a universe of 10,000, says CEO Isaac Souede. "We've never had a fraud; we've never had a blowup," says Shane Clifford, head of U.S. institutional sales.
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