Is Legg Mason’s Rebound Sustainable?

For many mutual fund investors,

The firm went through a rough time in the years surrounding the 2008 financial crisis and suffered big outflows, especially in its Western Asset subsidiary, but it has been working to recover and strengthen itself during the past few years under new CEO Joe Sullivan. Legg Mason has always had numerous bright spots from an investment perspective, though it's still a bit early to tell how well the firm's revamped structure will play out in the long term.

A Diverse Lineup Legg Mason operates on a multiaffiliate model, in which the parent company handles distribution and marketing while affiliates, all of them owned by Legg Mason, handle the investment side with a fair amount of autonomy. Unlike some other shops with similar models, most of the funds run by these affiliates are not branded as Legg Mason, so it's not obvious to a casual observer who their owner is. Just a few years ago, there were more than a dozen affiliates under the Legg Mason umbrella, but Sullivan has consolidated them while also making some purchases in an effort to fill holes and make the lineup more coherent. Now there are seven affiliates, each with its own investment culture and area of expertise: 1) ClearBridge does fundamentally driven equity investing; 2) Royce, long run independently, is centered around small-cap investing and collaboration among its research team; 3) Western Asset is a fixed-income manager traditionally focused on credit; 4) Brandywine Global does global fixed-income and global value equities; 5) QS Investors (bought in 2014 and merged with affiliate Batterymarch) is a quant shop that also does asset allocation; 6) Martin Currie (also bought in 2014) is a U.K.-based international-equity shop; and 7) Permal does alternatives.

Apart from Royce, which operates as a separate small- and mid-cap boutique, nearly all of Legg's actively managed domestic-equity funds are now part of ClearBridge. They include the former Salomon Brothers and Smith Barney funds, which Legg Mason got in a 2005 deal with

The biggest of Legg Mason's affiliates is Western Asset, which has roughly two thirds of the firm's $700 billion in assets under management. Although it's best known as a major player in institutional fixed-income investing, Western's mutual funds mostly have strong long-term track records, with Ken Leech and the team at

Western Asset has traditionally had a somewhat higher risk tolerance than many other big fixed-income shops and isn't afraid to make bets that run against the consensus. The firm's emphasis on credit investments has helped its funds in good times but hurt badly in the 2007-08 financial crisis, when poor performance (especially in Core Bond and Core Plus Bond) led to significant outflows. Western subsequently beefed up its risk management, hiring Ken Winston in October 2008 to head up those efforts and entwine them more closely with the day-to-day investment process. The firm also formed a separate risk-analysis and oversight team, headed by Rajiv Sachdeva, to stress-test ideas before they're implemented.

But several Western Asset portfolio managers and executives left the firm during this time, including veteran Ron Mass and newcomer Paul Jablansky, both from the structured products group (the source of much of the underperformance during the crisis), and Stephen Fulton, head of agency mortgage-backed securities. Star manager Leech, who was also serving as chief investment officer, took a medical leave of absence in 2008 but returned to portfolio duties the following year and to the CIO position in 2014. The firm has since clarified its succession planning, promoting Michael Buchanan to a co-CIO role to provide for a smooth transition.

The Road to Recovery In the wake of these problems, and partly because of pressure from activist investor Nelson Peltz, CEO Mark Fetting left in the fall of 2012. For a while there was some uncertainty about the direction Legg Mason would take, but things became clearer once Sullivan took over as permanent CEO in early 2013, after initially being appointed on an interim basis. He considered making the investment operations more centralized and integrated, but ultimately decided that it was better for investors to have the affiliates operating independently, with a lot of freedom to focus on what they do best. However, as noted above, Sullivan has reshaped the affiliate lineup from the top down, getting rid of some marginal affiliates, adding some new ones (notably QS and Martin Currie), and merging others that did similar things. These changes are designed to improve Legg Mason's growth prospects by streamlining the firm's structure and putting more emphasis on areas that are likely to do well and attract assets in the future, including international equities and liquid alternatives. Sullivan has also worked with some success to repair the parent company's relationship with the affiliates, which had become strained over such issues as revenue sharing.

The performance of the funds in Legg Mason's lineup has certainly improved since the depths of the financial crisis. The family's two largest funds, Western Asset Core Plus Bond and

Purely from an investment perspective, Legg Mason's lineup has always included some fine funds. Five of the firm's funds have Morningstar Analyst Ratings of Silver, including all four funds mentioned above, and another six earn Analyst Ratings of Bronze. From a stewardship perspective, though, the big question is whether all the recent firm-level changes have been good for fund shareholders, and here the jury is still out. The improved performance and asset flows have been nice to see, but the organizational changes are still new enough that caution is warranted. Also, with publicly traded asset managers like Legg Mason, there's always the potential for conflicts, because some things that are good for shareholders in the company's stock (such as gathering a lot of assets to generate earnings growth) may not be good for fund shareholders. There can also be pressure to meet short-term expectations even at the expense of long-term goals.

Legg Mason hasn't done anything obviously bad from a stewardship perspective, but it hasn't really stood out, either; its fund expenses as a whole are average, and manager investment in its funds is also middle of the road, though better than a few years ago. (Only one Western Asset fund has any manager investment, according to the Statement of Additional Information.) All this adds up to a Parent grade of Neutral.