Legg Mason CEO Mark Fetting moves beyond SIV debacle

Mark Fetting has revamped the corporate structure, boosted risk management, and is now looking how to grow Legg Mason, including acquisitions in emerging-market equities.

Legg Mason Global Asset Management, which as of September managed $703 billion of assets, has not had a 'good crisis', but its CEO, Mark Fetting, says the firm has taken the necessary steps to get back on track and is looking to deploy a war chest of $1 billion to grow its footprint in Asia.

A long-serving manager at Baltimore-based Legg Mason, Fetting was tapped to replace the firm's founder, Raymond "Chip" Mason, in early 2008. Whatever plans he had were then upturned by the market crisis that autumn.

"Everyone has gone through their own version of hell," Fetting says. In Legg Mason's case, it was the firm's large money-market funds in the United States, which were exposed to securities issued by investment banks' special instrument vehicles.

Some of these SIV securities defaulted, forcing Legg Mason to ultimately raise around $2.5 billion of capital (including an injection from KKR) to ensure its money-market funds run by its biggest subsidiary, Western Asset, didn't 'break the buck' by having their net asset values drop beneath $1. Ultimately the firm poured $1.5 billion of that capital into supporting the liquidity business.

That situation was resolved in early-2009, with clients reassured and distributors willing to put Legg Mason products back on the shelf, Fetting says.

Another aspect to the firm's trip to Dante's Inferno was related to performance. In 2008, Western Asset underperformed other major bond houses, such as BlackRock and Pimco, because of the nature of its investment philosophy, which is to seek out value in credit. In 2008, simply being in credit versus Treasuries was a recipe for disaster.

Fetting says performance in 2009 has been very good, but admits frustration that Western was dealing with 2008's problems at the very moment when fundraising for fixed income hit a fever pitch. The damage shows in Western Asset's AUM, which at September 2009 was at $507 billion, versus $585 billion in September 2008.

Legg Mason has gone through all of its franchises' investment processes. Fetting says the risk-management process has been strengthened, but also notes that Western's investment philosophy and process has been affirmed. The management team took its lumps because it was supposed to be exposed to credit, but it stayed true to what it stated it would do. In 2009, performance has bested peers, Fetting says.

Other parts of Legg Mason had troubled performance in 2008. Famed US equities investor Bill Miller saw the polish on his reputation scratched, but his fund has returned this year to top-quartile performance.

Fetting says performance is also strong at other family franchises, including US small-cap boutique Royce and US equities specialist ClearBridge. He is also bullish on funds of hedge funds unit Permal, although its fate remains tied to the general image problem of the asset class.

Although improved performance is required, Legg Mason has also looked at the way it manages these affiliates. Fetting calls the firm a franchise of franchises, and notes that before the credit crisis, Baltimore took a hands-off approach to how its boutiques operated.

Now it is getting more involved -- "engaged" is Fetting's preferred term -- with affiliates on strategic business issues. Legg Mason's corporate office has changed its leadership, including a new head of international business, Ron Dewhurst, who is centralising things like retail distribution.

The parent company is not touching boutiques' investment processes, nor their institutional sales efforts, but it is taking a central role in sales to retail and quasi-retail clients (such as managed pension accounts in the US).

It is also taking a more centralised approach to group risk management, and to deploying capital in order to invest in its affiliates, not just look to acquire new ones.

"It's a modified corporate strategy rather than a wholesale change," Fetting says.

He would not talk about specific plans for investing, but notes the example of Western Asset, which the firm acquired in 1986 as a $3 billion bond boutique. The franchise was left to grow organically for a decade, but then in the mid-1990s was bolstered by the acquisition of Lehman Brothers' fixed-income investment business; then by the purchase of Rothschild Asset Management's business in Singapore; and finally and decisively by the acquisition of Citigroup's asset management business.

By the time all of these fixed-income operations were rolled into Western Asset's, it had $500 billion under management.

Fetting says the firm would like to replicate this for some of its other franchises, either by bolting on acquired businesses, or lifting out teams from rivals.

This inevitably leads to the question of scale. Fetting cites the BlackRock/BGI deal. "That's a signature move," he says. But he notes that scale varies by asset class. In fixed income, you can't have enough, which is why Western is now among the top-three bond houses worldwide in terms of AUM. Scale works in large-cap equities but not in small caps, or emerging markets. In alternatives, scale provides benefits in the form of a diversified set of products and strategies; but not within many particular portfolios.

With Legg Mason over $700 billion (it should be close to $800 billion by year end), "we have the scale we need for the businesses we're in", Fetting says, thanks to buying Permal and trading Legg Mason's Baltimore-based brokerage for Citi's asset-management business.

"But as the business gets more global, we need to sell more globally," Fetting says, noting his trip this week to Asia has underlined his desire to see a bigger footprint in retail distribution in the region.

One area of growth is in global credit, and Legg Mason has registered a Western product with its offshore funds series.

Fetting wants to see other success stories from the equities side, particularly with regard to conservative products that provide dividend income -- the sort of thing that ClearBridge Advisors can do.

To finally banish the ghost of 2008 will also require seeing flows turn net positive: "OK, we've resolved the SIV issue, we've resolved the balance-sheet issues, and we've got $1 billion of excess cash. We've improved performance across asset classes. The next thing to address is that we still have modest net outflows."

Although outflows in the first quarter were a punishing -9%, this retreat has subsided. Last quarter saw net outflows of -1%, mainly from Western's core and core-plus, bread-and-butter business.

Fetting is confident gains will come from a variety of sources: the revival of the liquidity business; from equity managers including Royce and ClearBridge; from Western's global credit funds; from emerging-market equities run by Legg Mason International Equities or by its Asian specialist, Batterymarch; and from Permal, if funds of hedge funds return to favour.

A CEO has to be optimistic about his brands, of course, and Fetting is no exception. But he also understands 2010 holds some risks, mainly at the industry level, rather than for Legg Mason in particular.

A big one is clients' risk appetite. For example, hedge funds were invented to mitigate risks, but in the bull markets were transformed into aggressive, alpha-seeking strategies. Fetting believes the industry will revert to a lower-risk profile, which he thinks should benefit Permal, but he can't be sure investor demand will return at all.

Overall, he says, "institutional investors will come back quickly; retail investors will come back stronger." Legg Mason has a good balance between the two, so the emphasis will be more about geography.

Today 35% of the firm's AUM comes from outside the US, and Fetting's goal is to lift this to 50%.

His trip to Asia has underscored one area where the firm can act; it remains relatively light on the ground in terms of investment expertise. Patrick Tan runs equities in Singapore at Congruix, a franchise spun out of the Rothschild acquisition, while Crystal Chan runs Legg Mason International Equities in Hong Kong.

However, most of the group's equities teams focus on the US. So Fetting will look to use the firm's $1 billion kitty to support its existing teams in Hong Kong and Singapore, and look for acquisitions.

Legg Mason is also in the process of opening an office in Beijing. Its various franchises already run money for China's biggest investors, as well as for QDII mandates (for Citi's onshore wealth management business). But it would like to improve client service by situating people on the ground, who can better coordinate activities among all of the firm's franchises in Greater China.

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