Mark Fetting is eager to get off to a fast start as CEO of Baltimore-based Legg Mason. Just three days after being appointed successor to co-founder Raymond (Chip) Mason on January 28, Fetting announced that private equity giant Kohlberg Kravis Roberts & Co. was buying $1.25 billion of bonds convertible into a 9 percent stake in the firm. Now Fetting, 53, is preparing to spend much of that trove to expand — he is searching for an international equity manager with strength in alternative assets. Late last month he announced that he had spent $180 million to buy back shares from Citigroup, which acquired them as part of a 2005 deal in which Mason swapped his brokerage arm and a 13 percent stake for the bank’s investment management unit.
“Our model has always been one of buy and build,” says Fetting. “Now we can spend even more time making sure we move quickly through acquisitions.”
The CEO has reason to move quickly. Legg Mason’s $133 billion mutual fund complex is suffering from sorry performance, which, combined with the costly integration of Citi’s Smith Barney funds, has hurt profits. According to Denver-based mutual fund rating agency Lipper, the average performance of Legg-branded mutual funds fell from the mediocre 57th percentile in 2006 to the 64th percentile last year. Among the worst performers is the $14.74 billion Legg Mason Value Trust fund, managed by the renowned William Miller, which ended a 15-year winning streak against the Standard & Poor’s 500 index when it sank to the 99th percentile among its Morningstar peers in 2006 and 2007.
Legg also suffered a black eye in December. It had to issue guarantees and inject $1.1 billion in cash to rescue two institutional money market funds inherited from Citigroup that stumbled on investments in structured investment vehicles. The move cost Legg $23 million in fourth-quarter earnings.
Disenchanted investors last year withdrew $6.7 billion in assets from the firm’s mutual funds, one of the most profitable areas of Legg’s $1 trillion asset management business. That was the third-biggest net outflow among the 25 largest mutual fund complexes in the U.S., as surveyed by Financial Research Corp. (Putnam Investments shed $12.5 billion, and American Century Investments lost $9.9 billion.) Net income for Legg’s third fiscal quarter, ended December 31, fell 11.5 percent from a year earlier, and the firm’s share price has dropped by about 43 percent since January 2006, to $69 a share, even as competitors’ rose (Baltimore rival T. Rowe Price is up 44 percent).
Fetting is pushing Legg’s 15 subsidiaries to improve their investment processes, but, for now anyway, he says he isn’t planning any big change in portfolio managers. Nor does he intend to push managers to modify their investment styles. In his last job, as head of the firm’s mutual fund business, Fetting says he did all he could to “contain” underperformance and improve returns by integrating the Smith Barney funds into Legg and reducing the number of open-ended funds, from 166 to 119.
“The managers are working hard, and their returns will get back to what has been a very strong and compelling track record of long-term outperformance,” says Fetting.
The CEO is evidently feeling no pressure from KKR, which first entered into negotiations with Legg in late fall and, judging from the terms of the deal, appears to be making a long-term, deep-value play. On January 31, KKR bought a seven-year $1.25 billion bond with a coupon of 2.5 percent convertible by 2015 into a 9 percent equity stake at $88 a share, a 25 percent premium to the share price then. Executives at KKR, which will have a seat on Legg’s board, decline to discuss the transaction. Notes Robert Lee, an analyst at Keefe, Bruyette & Woods in New York, “KKR is a patient investor.”
Meantime, Legg searches for a new asset manager. Mason, 71, will stay on as non-executive chairman, working his global client relationships to identify targets. Fetting says he will approve or reject Mason’s choices and take charge of integrating any acquisition. The CEO hopes to repeat the success of the 2005 purchase of Paris-based fund of hedge funds Permal Group, which earned $23 million in performance fees last year.
Fetting sees the strongest growth potential in alternatives and non-U.S. assets. Last month he appointed a new head of international asset management, Australian Ronald Dewhurst, a J.P. Morgan veteran whom Fetting has charged with “executing Legg Mason’s global growth strategy.” Fetting says he hopes to announce the acquisition of a “substantial” international firm in the next few months.
The CEO told securities analysts last month that he had used some of KKR’s money to buy back 2.5 million Legg shares, or about 2 percent of the firm’s equity, from Citigroup. He was worried that the struggling Citi might dump the stock, depressing Legg’s share price, before its funds could recover. (Citi now holds 700,000 shares, or roughly 0.5 percent of Legg’s equity.)
Fetting first met Mason in the late 1980s when, as a consultant at Greenwich Associates, he advised Legg to grow the asset management business through acquisition. When he joined the firm as head of its mutual fund complex in 2000, after stints at T. Rowe Price, Citi and Prudential Financial, Fetting was widely regarded as Mason’s heir apparent. But Mason passed him over in July 2006, instead promoting James Hirschmann, CEO of subsidiary Western Asset Management Co., a fixed-income specialist, to chief operating officer and de facto CEO-in-waiting. Hirschmann bowed out less than a year later, returning to his old job at Western’s headquarters in Pasadena, California. Meanwhile, Fetting oversaw the restructuring of Legg’s mutual fund complex. Late last year Legg’s board decided to name Fetting CEO. True to his reputation as “Chip’s right hand,” says Harold Adams, a board director and head of Legg’s executive search committee, “he came in with a plan for the future that impressed all of the board members.” Fetting’s blueprint included the planned acquisition and the share buyback from Citi, says Adams, who declined to go into further detail.
