Legg Mason rejects US sub-prime fears

Managers at the $20.8 billion Value Trust say now is the time to buy America.
Mary Gay, portfolio manager on Legg MasonÆs $20.8 billion monster-sized blue-chip fund, argues that positive economic data outweighs the bad news out of the sub-prime story that has rocked the market in recent weeks.

The fund, lead managed by Bill Miller from Legg MasonÆs Baltimore head office, has a 25-year history of investing in US mega- and large-cap equities. Portfolio manager Gay argues that the economic environment should encourage investors to return to the asset class, which has fallen out of favour among domestic investors.

ôThere have been flows out of local equity funds in the US,ö says Gay. ôThere is a high correlation between money chasing what has done well and this does not reverse until new areas start doing well. Inflows from international clients have been much stronger as they see periods of under-performance as a good time to invest in the fund.ö

A macroeconomic environment that is slowing rather than slipping is the key indicator that investors should enter the asset class, she argues. ôFor there to be a recession there would have to be a high level of unemployment and inflation. The former is around its historical average at 5% (core inflation is at 2.25%). Incomes are quite high. There is a problem in sub-prime but we feel that if it is in the papers then it is probably in the price (of sector stocks) as well.ö

US large caps, however, provide a liquid and low volatility environment compared to other markets, with the top 10 stocks in terms of market capitalisation representing much less of the whole than other economies such as India. Despite internal difficulties much earnings growth is likely to come from overseas trading partners. Furthermore, the last few years have seen AmericaÆs biggest companies be little rewarded for their efforts.

ôThere has been relative underperformance in the last five or six years,ö Gay says. ôBut
there has also been a huge level of capital build-up. Capex has been virtually non-existent since the 1990s and companies will soon be forced to return much of this.ö

This will occur, she adds, under pressure from private equity, shareholder activists and hedge funds: ôLast year merger and acquisition in the US was worth $4 trillion and we expect this will be surpassed in 2007.ö

The market itself should be buoyed by significant earnings growth, as she explains: ôThe early 1990s saw similar growth in emerging markets to today. Large cap US stocks were enjoying single digit returns that lagged behind earnings but these moved to double digits in 1995 and continued for three more years.ö

Legg Mason is opening offices in Hong Kong, Singapore and Taiwan. This is something of a re-launch, given it has acquired existing regional businesses from Citigroup Asset Management as well as Rothschild Asset Management in Singapore. It has registered 20 funds from its Dublin-domiciled range in Hong Kong. The company is in the process of lining up local distributors.

Legg Mason estimates that 30% of its $944 billion business comes from outside the US. Terence Johnson, managing director of international distribution, says although it had no immediate plans to enter the China market it was keeping an eye on developments there.
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