A Glimpse Behind the Curtain at Western Asset Management

Western Asset Management has long been known as a leader among institutional fixed-income investors, but the firm is still relatively unfamiliar to retail investors. A subsidiary of  Legg Mason , the firm's fixed-income assets peaked at $521 billion in 2006 thanks to an impressive long-term track record. But investor confidence in the Pasadena-based fixed-income shop was shaken in 2007 and 2008 when the firm's flagship core and core plus bond portfolios were tripped up by large stakes in nonagency mortgage-backed securities, corporate-bond missteps, and the assumption of too much risk overall. Underperformance across the firm's lineup during the financial crisis revealed some flaws, including weaknesses in credit research, ineffective risk oversight, and gaps in communication between macro and fundamental research.

The firm was besieged by outflows in the aftermath, and its fixed-income asset base hasn't fully recovered: it stood at roughly $434 billion as of June 30. The company has made substantial strides to address its problems in the roughly five years since the firm's disappointing run in 2008. The firm made several key hires, for example, including Ivor Schucking, who was co-head of credit research at PIMCO and has extensive experience with financials. And while the credit-analyst ranks have gone through a shakeup--around half the team joined WAMCO since 2009--its credit research arguably remains a draw here. They've focused on adding highly experienced analysts in the past few years, and the firm currently boasts 12 high-yield analysts with 18 years of experience, on average (ranging from 14 to 26 years), and another 15 investment-grade analysts who are similarly seasoned.

The firm also hired Ken Winston in October 2008 as its head of risk management, who has since built a team of roughly 30 professionals dedicated to the task. That team's latest endeavor is building a proprietary risk system that will aggregate all relevant data on a single platform to enable a more comprehensive estimate of risk. The firm also formed a separate risk-analysis and oversight team, headed by Rajiv Sachdeva, whose mandate is to stress-test investment ideas before they're implemented. WAMCO's team of generalist portfolio managers have also focused on better integrating the firm's fundamental and macro research and have worked to ensure that communication between the traders, portfolio managers, and research analysts is fluid.

In aggregate, these changes and investments in resources appear to have put the firm on stronger ground. Fortunately for investors that stuck around, performance across a number of funds that lagged badly during the crisis, including flagship  Western Asset Core Plus Bond (WACPX), have also rebounded strongly and reclaimed impressive long-term track records. Of late, we've rated six open-end funds managed by WAMCO, five of which have received a Morningstar Analyst Rating of either Bronze or Silver, demonstrating our overall conviction in their investment professionals and process. 

High-Level Changes in the Structured Products Group Raise Some Concern
We believe there's reason for continued optimism in the firm's overall prospects, but some recent personnel changes warrant a watchful eye. For starters, there has been tumult in the firm's structured-products group. As noted, WAMCO had problems in the nonagency mortgage-backed space during the financial crisis, and the firm brought in additional resources to assist Ron Mass, a 21-year firm veteran, who was serving as head of structured products. In particular, Paul Jablansky was hired in 2011 from Royal Bank of Scotland to serve as co-head of the group, because the firm believed his macro-related experience would be a good complement to Mass' relative-value expertise. After roughly 18 months of working with Jablansky, Mass departed the firm in mid-2012. Because the underlying team responsible for research and trading remained in place, the firm didn't feel a need to replace him.

The calm didn't last long: Jablansky abruptly resigned from the firm in June 2013. WAMCO's external search led the firm to hire Anup Agarwal in July 2013, who joined with 16 years of experience. He previously served as a portfolio manager and head of consumer credit for Stark Investments, an alternative investment firm. There he was responsible for managing a full range of securitized assets, including agency and nonagency residential mortgages, as well as commercial mortgage-backed and asset-backed securities. He also spent four years as the head of credit & research in Invesco's fixed-income group prior to that.

As if that weren't enough, the firm's head of the sector team responsible for agency mortgage-backed securities, Steven Fulton, announced his plans to retire effective Sept. 30, 2013. Fulton held that post for the past four years and spent a total of 14 years at the firm. WAMCO is not replacing him; the team's underlying analysts will report directly to Agarwal.

Clearly, there are several moving pieces to consider as the structured products group digests these changes. It is worth noting that the firm's structured products analyst staff has been very stable and is relatively long-tenured with an average of 13 years of experience, helping alleviate some concern.

Chief Investment Officer Transition Is Well Under Way
There's more going on upstairs, as well. Steven Walsh, WAMCO's chief investment officer since August 2008, announced in early 2013 that he intends to retire effective April 1, 2014. Walsh has been with the firm since 1990, serving as deputy CIO from 1998 to 2008 until he stepped in as sole CIO when Kenneth Leech took a leave for medical reasons. Leech returned to the firm on a day-to-day basis upon receiving a clean bill of health in mid-2009, serving as chairman of the firm's global strategy committee and as a key member of the U.S. broad market committee. Upon Walsh's retirement, Leech will return to the CIO post that he'd held for nearly a decade, which should provide continuity and help facilitate a smooth transition.

Since the time of that announcement, Walsh and Leech have been serving as co-CIOs and will continue to do so until Walsh's retirement. Leech had already been operating as lead portfolio manager on the firm's global portfolios, and during the first six months of the transition period, he has focused on institutionalizing the firm's processes globally to ensure the improved integration across teams continues seamlessly as his responsibilities broaden. He has also been gradually expanding his formal management responsibilities of the broad U.S. portfolios, becoming more intimately involved in the management of  Western Asset Core Bond (WATFX) and Western Asset Core Plus Bond, for example. WAMCO notes that the transition process has been fluid thus far, aided by the firm's team-based investment management process and the fact that Leech has served as a key member on the firm's investment committees since his return in 2009. While Walsh's presence will certainly be missed, he leaves a very capable team behind.

Given some of these organizational disruptions, we continue to closely monitor the situation to ensure they don't derail the firm's progress as it seeks a spot among the upper echelon of fixed-income managers, both in the institutional and retail space. WAMCO's significant investments in firm resources and improvements to the investment and risk management processes help bolster confidence that the firm should continue to find success, but they do raise some concerns that are worth keeping a close eye on.