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Legg focused on reversing fund withdrawals

Legg Mason Inc. has bounced back from the worst of the financial crisis by many counts.

The Baltimore financial powerhouse has cleaned up its balance sheet without government help, returned to profitability and initiated a major cost-cutting program to boost profit margins.

Yet one key measure stands in the way of a full recovery: Clients continue to pull money from Legg Mason's mutual funds even as the market rebounds and shell-shocked investors regain their footing. For 13 consecutive quarters, clients have taken more money out of the funds than they put in, resulting in billions of dollars being moved out of Legg accounts.

Last week, while posting a profit for the most recent quarter, Legg announced that net fund withdrawals had worsened from the previous period to nearly $17 billion, disappointing analysts and Wall Street. The news sent Legg's stock down 5 percent, the largest one-day slide in eight months.

The setback underscores the imperative of reversing withdrawals. Legg and other financial services firms laid off workers to cope with shrinking assets during the depths of the recession. Now, Legg could see growth stall until the company can woo investors back, said Matt Snowling, an analyst at FBR Capital Markets.

"Clearly, that is the final chapter to complete the turnaround," Mark R. Fetting, Legg's chairman and chief executive, acknowledged in an interview.

He said the company is up to the task. Fundamental financial measures, including earnings and the balance sheet, have improved, as has the performance of some of Legg's mutual funds.

"Therefore, the spirit across our firm is very much on the upbeat," Fetting said. "It's game on."

Wall Street analysts, however, aren't so upbeat.

At this point, efforts to improve fund inflow at Legg are "still more talk than substance," Douglas Sipkin, an analyst at Ticonderoga Securities, wrote in a research note.

And despite measurable improvements, Legg lags behind competitors, said J. Jeffrey Hopson, an analyst at Stifel Nicolaus. While Legg is not the only money manager seeing withdrawals, others are increasing assets, Hopson noted.

Baltimore's T. Rowe Price Group is one of them. Price announced Friday that its assets under management at the end of last year reached a record $482 billion. That is more than in the high-flying days before the recession, even though market indexes remain far below records set then. For the year, clients poured a net $30.3 billion into Price's funds and other accounts.

Hopson, who had predicted that Legg would stop bleeding assets and start showing positive fund flows by March, now believes the company will not turn that corner until June.

In the quarter through December, Legg clients withdrew a net $16.7 billion from its stock, bond and money market accounts, up from $12.7 billion in the previous three months. Net withdrawals amounted to $63 billion last year. While it was an improvement over $134 billion of net client redemptions in 2008 — a high-water mark — the latest withdrawals were not encouraging.

At its peak, Legg managed more than $1 trillion for clients. Then the worldwide financial crisis pushed Legg and other money managers into a freefall as spooked investors withdrew record amounts from their mutual funds and other investments.

Today, Legg manages $671.8 billion in assets.

In recent years, Legg never seemed to be positioned to fully capitalize on market trends — a skill at the heart of a money manager's livelihood.

The company's assets under management are heavily weighted toward the bond market, where many investors flocked in recent years; those fixed-income and liquidity or money market funds account for 73 percent of its assets. But its California-based subsidiary Western Asset Management, which specializes in bonds, saw an uptick in fixed-income withdrawals.

Wells Fargo Securities analyst Jim Shanahan said the company "may have missed its best opportunity to grow organically when industrywide flows were stronger into fixed income."

And as embattled investors return to the stock market, Legg might not benefit as much as other money managers because equity represents little more than a quarter of its assets, according to analysts. Moreover, Legg's stock fund performance last year was mixed, analysts said.

"I would not categorize 2010 as a good year for their equity franchises," said Dan Fannon, a research analyst with Jefferies & Co.

Performance at famed stock picker Bill Miller's Legg Mason Capital Management division in Baltimore has been spotty, Fannon said. Those flagship funds were among the worst performers in the industry in 2008. That included the once-formidable Value Trust fund, managed by Miller, who is known for beating the S&P 500 index for 15 straight years before the streak ended in 2006.

Hopson said it is hard to win back investors once they have taken their money elsewhere because competition is greater than ever. "Once you lose your spot on the retail space, even if you have a great performance, it takes a lot to get back on those shelves," he said.

Legg executives have attributed some of the withdrawals to clients pulling money out of municipal bonds, an industrywide trend spurred by rising interest rates and fear that cash-strapped states and municipalities would default.

Fetting also pointed to a broader market shift in which some larger institutional investors moved away from fixed-income funds to more specialized, high-yield, global and emerging market products. So, while clients have withdrawn money from Western Asset's flagship funds, it has picked up new, higher-fee business on the specialized asset class, Fetting said.

Small-cap specialist Royce & Associates and Permal Group, which invests in hedge funds on behalf of clients, are other bright spots, having generated net deposits in the most recent quarter.

Fetting has been talking about a turnaround since he became chief executive in January 2008 during one of the company's most difficult periods. That year, the firm posted its first quarterly loss since becoming a public company in 1983. And fund withdrawals began accelerating while Legg continued to bail out some of its money market funds invested in toxic securities.

Since then, Legg has cleaned up its balance sheet and returned to profitability in 2009 after five consecutive quarters of losses. Last year, Legg initiated a major cost-cutting program to boost profit margins by eliminating 350 back-office jobs, including 250 in the Baltimore area. A total of $140 million in savings from that move is expected to fully materialize by March 2012.

With those changes in place, Fetting said the firm is ready to tackle persistent client withdrawals.

Corporate executives, including Fetting, and the firm's various affiliate fund managers have been meeting with clients, prospective investors and sales partners around the world. Fetting planned to head this weekend to the Middle East to meet with large sovereign clients, while Western Asset's executives went to Europe and Asia in early January.

Fetting said the company is positioning itself to grab opportunities in the market. On the equity side, managers are trying to attract new investments with positions in blue-chip, dividend-paying companies. Western Asset managers are talking to U.S. pension clients about global funds.

To finish writing Legg's turnaround story, the company must continue to land new business, Fetting said.

"Are we keen on completing the final chapter? Absolutely," he said. "Are we confident that we will conclude the final chapter? Absolutely."

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