Legg chief defends company model

The Baltimore Sun

The honeymoon didn't last long for Mark. R. Fetting.

Legg Mason Inc.'s new chief executive walked into the job in January during one of the company's most difficult times.

The firm recently posted its first quarterly loss since becoming a public company in 1983.

Clients keep taking their money elsewhere amid slumping performance of key mutual funds, including the flagship Legg Mason Value Trust. And Legg is still bailing out some of its money market funds because of soured mortgage-related investments.

Now, the Baltimore company faces questions about whether its recent problems go beyond poor performance by star managers to how Legg's business is organized. Fetting inherited a system from Legg patriarch Raymond A. "Chip" Mason that allows the company's fund managers to operate their businesses independently, with minimal investment direction from headquarters.

At least one analyst says the firm should restructure Legg Mason Capital Management, home of the Value Trust fund run by star manager Bill Miller. And another asked Fetting recently whether he would consider selling any of its businesses.

Such challenges go against the foundation that Chip Mason established to build a mid-size stock brokerage into a global asset-management business. And while improving Legg's recent weak performance is a top priority, Fetting insists that he's not about to change the century-old company's business model.

"At a time when you have a couple of managers underperforming, there are some who are, in our view, overreacting by suggesting that we should upset the apple cart," said Fetting, in his first extensive interview since taking the job.

Fetting points to Legg's key successes during the past decade: evolving into a diversified money manager through purposeful acquisitions and giving fund managers investment independence; increasing cash earnings to $877 million, excluding noncash charges; and growing assets under management from $70 billion to $950 billion.

"The proof will be in the pudding as performance returns to its long-term norms in the managers who are showing some issues," Fetting added. "I think then we will be vindicated."

But the challenges appear daunting. Legg shares have plunged 25 percent this year, on top of 25 percent last year. Clients have pulled money from the company's stock funds every quarter since the July-September 2006 period, according to regulatory filings. Investors withdrew about $44 billion during the fiscal year that ended March 31.

And profits suffered after Legg took several charges to support some of its money market funds hampered by mortgage-backed investments.

It wasn't always this bad. Legg stock soared to $136 in early 2006 after a deal was completed to acquire Citigroup Inc.'s asset management group. Shares closed at $54.07 yesterday.

But Wall Street is fickle, analysts say.

"When you have underperformance and outflows ... you have to do something about it," said Benjamin Poor, a director at Cerulli Associates, a Boston financial services research firm. "It may be a tough position for management to be in."

Legg expanded rapidly in the past two decades, mostly through key acquisitions. It now has 14 subsidiaries, including Western Asset Management Co., its largest unit focused on fixed-income products, and fast-growing Permal Group, which invests in hedge funds on behalf of clients.

Each subsidiary generally operates as a separate business, an approach supported by agreements that pay most money managers a percentage of revenue. As the parent company, Legg provides legal, compliance, technology and back-office functions as well as added distribution and risk-management support and resources.

Analysts say that it is fairly common in the money-managing business to have independent managers focus on different investment strategies and that Legg should neither be singled out or counted out.

"It's hard to go and tamper with that. I don't think they want to or should," said Robert Lee, an analyst at Keefe, Bruyette & Woods, referring to Legg's model.

Mason, who was CEO for 38 years and is now nonexecutive chairman, says critics are looking for something to blame when "there's nothing in that model that didn't work before that shouldn't work now."

Instead, Mason notes the years of stellar performance by Miller and another well-known manager, Bruce Sherman, who runs Private Capital Management.

"At what time would you step in and at what time would you say, 'You've got to change and you're doing it wrong'?" Mason said from Legg headquarters, where his desk sits near Fetting's office. "I think the people who run that money are the same people, and they did such a great job. I believe they will come back and do a good job again. But that truly will be Mark's call."

Fetting says he's confident in his fund managers, whom he met with during the first 90 days of his tenure for what he has called "candid discussions" about performance.

He notes his close working relationships with the managers because of his previous job as head of Legg's mutual funds. Fetting joined Legg in 2000.

He says management will continue to support managers so they can focus on investing and improving performance.

"Our model is one where we're not going to go in and second-guess the investment decisions," Fetting said. "If we got the right firm, the right leadership and the right investors, they will over time deliver excellent results. And that has been the case."

Analyst Douglas Sipkin of Wachovia Capital Markets recently offered a "to-do" list for Fetting, which included reducing the Value Trust's size and implementing changes at Legg Mason Capital Management. "The underperformance there has lasted for more than a couple of years. Reliance on [10-year] numbers does not seem like a winning strategy," he said in a March research note.

Much of blame has fallen on Miller, who is known for beating the S&P; 500 index for 15 straight years before ending in 2006. Since then, the Value Trust fund has been struggling as its assets dropped to $12 billion as of March 31, from $20 billion in the corresponding period last year.

He's not the only one who has struggled, though. Sherman's Private Capital Management, which manages money for wealthy clients, has seen investors walk away. The firm's assets shrank to $9 billion from $22 billion a year ago, according to regulatory filings.

And ClearBridge Advisors, the equity division acquired from Citigroup, also has suffered in recent quarters. Miller and Sherman declined to comment.

Asset growth at other subsidiaries, including Permal and Brandywine Global Investment Management of Philadelphia, was not enough to offset client withdrawals at those key equity shops.

Legg said its managers, particularly Sherman and Miller, have bounced back from down cycles. Burton J. Greenwald, a consultant to the mutual fund industry, likened Miller to a slumping baseball hitter who will get his groove back.

Brian C. Rogers, chairman and chief investment officer at Baltimore's T. Rowe Price, is betting on better days for Legg.

Rogers, who also manages T. Rowe Price Equity Income Fund, recently added 2.5 million Legg shares to the fund's portfolio. Collectively, Price is the third-largest shareholder, with 5.4 million, or 4 percent, of Legg shares.

"My view is that good companies react to adversity and adapt, and I think Legg has a lot of well-publicized issues out there," he said yesterday. "I also think Legg Mason is a pretty good company, and it will adapt."

To make its case, Legg shared data that indicated that every top- performing stock fund has experienced weakness during the past 25 years.

Fetting acknowledges that Legg's issues are not "susceptible to quick fixes." But he believes financial and credit markets are showing positive signs. Some Legg funds, too, have seen improvements in recent weeks, Fetting said.

Still, recent performance woes in the asset management business have stirred buyout talks, including of Legg's units. And an analyst asked Fetting during a conference call this month whether any of Legg's businesses could be sold.

In response, Fetting said, "We think our businesses are all performing well and like our business model."

When asked about the possibility again, Fetting was more direct.

"Certainly, in our case, we've had no discussion about selling any of our affiliates," he said. "We appreciate the fact that they're highly desired, but they are best as part of Legg Mason."

hanah.cho@baltsun.com

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