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LM > SEC Filings for LM > Form 10-Q on 6-Nov-2012All Recent SEC Filings

Show all filings for LEGG MASON, INC.

Form 10-Q for LEGG MASON, INC.


6-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Legg Mason, Inc., a holding company, with its subsidiaries (which collectively comprise "Legg Mason") is a global asset management firm. Acting through our subsidiaries, we provide investment management and related services to institutional and individual clients, company-sponsored mutual funds and other investment vehicles. We offer these products and services directly and through various financial intermediaries. We have operations principally in the United States of America ("U.S.") and the United Kingdom ("U.K.") and also have offices in Australia, Bahamas, Brazil, Canada, Chile, China, Dubai, France, Germany, Italy, Japan, Luxembourg, Poland, Singapore, Spain, Switzerland and Taiwan. Terms such as "we," "us," "our," and "Company" refer to Legg Mason.

The financial services business in which we are engaged is extremely competitive. Our competition includes numerous global, national, regional and local asset management firms, broker-dealers and commercial banks. The industry has been impacted by continued economic uncertainty, the constant introduction of new products and services, and in prior years, by the consolidation of financial services firms through mergers and acquisitions. The industry in which we operate is also subject to extensive regulation under federal, state, and foreign laws. Like most firms, we have been and will continue to be impacted by regulatory and legislative changes. Responding to these changes, and keeping abreast of regulatory developments, has required us to incur costs that continue to impact our profitability.

Our financial position and results of operations are materially affected by the overall trends and conditions of the financial markets, particularly in the United States, but increasingly in the other countries in which we operate. Results of any individual period should not be considered representative of future results. Our profitability is sensitive to a variety of factors, including the amount and composition of our assets under management, and the volatility and general level of securities prices and interest rates, among other things. Sustained periods of unfavorable market conditions are likely to affect our profitability adversely. In addition, the diversification of services and products offered, investment performance, access to distribution channels, reputation in the market, attracting and retaining key employees and client relations are significant factors in determining whether we are successful in attracting and retaining clients. In the last few years, the industry has seen flows into products for which we do not currently garner significant market share. For a further discussion of factors that may affect our results of operations, refer to Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended March 31, 2012.

Our strategy is focused on three primary areas listed below. Management keeps these strategic priorities in mind when it evaluates our operating performance and financial condition. Consistent with this approach, we have also listed below the most important matters on which management currently focuses in evaluating our performance and financial condition.
Outstanding independent investment managers:

            The investment performance of our asset management products and
             services compared to their benchmarks and to the performance of
             competitive products for the trailing 1-year, 3-year, 5-year, and
             10-year periods.


            Our assets under management ("AUM"), the components of the changes
             in our AUM amid continued market uncertainty, the long-term trend of
             outflows in AUM in our recent history, the mix of our AUM among
             equity, fixed income, and liquidity assets, and the resulting impact
             of changes in AUM on our revenues.

A corporate center that delivers strategic value:

            Promote revenue growth through strategic marketing of products to
             institutional clients, supported by retail and quasi-institutional
             (e.g., 401(k) plans) distribution globally.

Management of expenses.

Allocating capital for diversified growth and returning capital to shareholders as appropriate:

            The amount of excess capital we generate, and deployment of that
             capital through share repurchases, investments in proprietary fund
             products, dividends and targeted acquisitions.

The following discussion and analysis provides additional information regarding our financial condition and results of operations.


Business Environment
While the financial environment in the United States remained uncertain during
the three and six months ended September 30, 2012, positive news regarding
increased consumer confidence, declines in unemployment, and manufacturing
growth gave indications that the economy may be rebounding, albeit at a slow
rate. Despite the continuing crisis related to the European sovereign debt, all
three major U.S. equity market indices, along with the Barclays Capital Global
Aggregate Bond Index and the Barclays Capital U.S. Aggregate Bond Index
increased for the three and six months ended September 30, 2012, as illustrated
in the table below:
                                     % Change as of and for the three        % Change as of and for the six
                                        months ended September 30:             months ended September 30:
Indices(1)                               2012                 2011              2012                 2011
Dow Jones Industrial Average             4.32 %               (12.09 )%         1.70 %               (11.42 )%
S&P 500                                  5.76 %               (14.33 )%         2.29 %               (14.66 )%
NASDAQ Composite Index                   6.17 %               (12.91 )%         0.80 %               (13.15 )%
Barclays Capital U.S. Aggregate
Bond Index                               1.58 %                 3.82  %         3.68 %                 6.20  %
Barclays Capital Global
Aggregate Bond Index                     3.27 %                 0.97  %         3.91 %                 4.10  %

(1) Indices are trademarks of Dow Jones & Company, McGraw-Hill Companies, Inc., NASDAQ Stock Market, Inc., and Barclays Capital, respectively, which are not affiliated with Legg Mason.

During the three months ended September 30, 2012, the Federal Reserve Board held the federal funds rate at 0.25%. We expect economic challenges to persist and cannot predict how these uncertainties will impact our results.

Quarter Ended September 30, 2012, Compared to Quarter Ended September 30, 2011

Assets Under Management

Our AUM is primarily managed across the following asset classes:
Equity                          Fixed Income                      Liquidity

  Large Cap Growth               U.S. Intermediate                U.S. Managed Cash
                                   Investment Grade
  Large Cap Value                U.S. Government                  U.S. Municipal Cash
                                   Intermediate
  Equity Income                  Global Government
  Mid Cap Core                   U.S. Municipal
  Small Cap Core                 U.S. Long Duration
  International Equity           Government/Credit
  Global Equity                  Global Fixed Income
  Global Emerging Market         Global Opportunistic
   Equity                          Fixed Income
                                  U.S. Corporate
                                  U.S. Limited Duration


The components of the changes in our AUM (in billions) for the three months ended September 30 were as follows:

                                                   2012        2011
Beginning of period                              $ 631.8     $ 662.5
Investment funds, excluding liquidity funds(1)
Subscriptions                                       10.0        11.4
Redemptions                                        (10.5 )     (14.2 )
Separate account flows, net                         (8.3 )     (12.3 )
Liquidity fund flows, net                            9.0        (2.5 )
Net client cash flows                                0.2       (17.6 )
Market performance and other (2)                    20.7       (32.9 )
Dispositions                                        (2.0 )      (0.2 )
End of period                                    $ 650.7     $ 611.8

(1) Subscriptions and redemptions reflect the gross activity in the funds and include assets transferred between funds and between share classes.
(2) Includes impact of foreign exchange, reinvestment of dividends, and other.

AUM at September 30, 2012, was $650.7 billion, an increase of $18.9 billion, or 3%, from June 30, 2012. The increase in AUM was attributable to market appreciation of $20.7 and net client inflows of $0.2 billion, partially offset by dispositions of $2.0 billion. The dispositions were in liquidity assets, which resulted from the amendment of historical Smith Barney brokerage programs discussed below. The $0.2 billion in net inflows consisted of $9.7 billion of inflows in liquidity assets largely offset by equity and fixed income outflows of $5.7 billion and $3.8 billion, respectively. Equity outflows were primarily experienced in products managed by Batterymarch Financial Management, Inc. ("Batterymarch"), Royce & Associates ("Royce"), and Legg Mason Capital Management, LLC ("LMCM"). Due in part to investment performance issues in some products, we have experienced quarterly outflows in our equity asset class since fiscal 2007, with the exception of the quarter ended June 30, 2010. We generally earn higher fees and profits on equity AUM, and outflows in this asset class will more negatively impact our revenues and Net Income than would outflows in other asset classes. Fixed income outflows, primarily in products managed by Western Asset Management Company ("Western Asset"), included $1.7 billion in outflows from a single, low-fee global sovereign mandate. We expect to continue to experience outflows from this mandate of approximately $500 million to $1 billion per month during the remainder of fiscal 2013. With the exception of the June 2012 and June 2011 quarters, we have experienced quarterly outflows in our fixed income asset class since fiscal 2008.

AUM increased by $38.9 billion, or 6%, compared to September 2011. The AUM increase was attributable to market appreciation of $58.4 billion partially offset by net client outflows of $8.6 billion and dispositions of $10.9 billion. Long-term net outflows from our equity and fixed income asset classes were $19.4 billion and $13.6 billion, respectively. Liquidity net inflows were $24.4 billion. Equity outflows were primarily in products managed at Batterymarch, Royce, LMCM, and ClearBridge Advisors LLC ("ClearBridge"). Fixed income outflows in products managed by Western Asset, which included $9.9 billion in outflows from the single, low-fee global sovereign mandate previously discussed, were offset in part by net inflows in products managed by Brandywine Global Investment Management, LLC ("Brandywine"). Dispositions of $10.9 billion were comprised of $8.1 billion in liquidity assets, transferred in connection with the amendment of historical Smith Barney brokerage programs discussed below, and $2.8 billion as a result of the disposition of a small wealth manager.

During the first quarter of fiscal 2012, Morgan Stanley Wealth Management, formerly Morgan Stanley Smith Barney, amended certain historical Smith Barney brokerage programs providing for investment in liquidity funds that one of our asset managers manage that resulted in a reduction of $4.6 billion in liquidity AUM during the first quarter of fiscal 2013. The final $2 billion in liquidity assets related to this relationship were transferred in July 2012.


AUM by Asset Class
AUM by asset class (in billions) as of September 30 was as follows:
                           % of                % of       %
                 2012     Total      2011     Total    Change
Equity         $ 153.4      23 %   $ 144.9      24 %      6 %
Fixed Income     369.4      57       355.5      58        4
Liquidity        127.9      20       111.4      18       15
Total          $ 650.7     100 %   $ 611.8     100 %      6 %

The component changes in our AUM by asset class (in billions) for the three months ended September 30 were as follows:

                                                            Fixed
                                               Equity      Income      Liquidity       Total
June 30, 2012                                 $ 151.1     $ 360.6     $    120.1     $ 631.8
Investment funds, excluding liquidity funds
Subscriptions                                     3.9         6.1              -        10.0
Redemptions                                      (6.2 )      (4.3 )            -       (10.5 )
Separate account flows, net                      (3.4 )      (5.6 )          0.7        (8.3 )
Liquidity fund flows, net                           -           -            9.0         9.0
Net client cash flows                            (5.7 )      (3.8 )          9.7         0.2
Market performance and other                      8.0        12.6            0.1        20.7
Dispositions                                        -           -           (2.0 )      (2.0 )
September 30, 2012                            $ 153.4     $ 369.4     $    127.9     $ 650.7



                                                            Fixed
                                               Equity      Income      Liquidity       Total
June 30, 2011                                 $ 181.5     $ 365.4     $    115.6     $ 662.5
Investment funds, excluding liquidity funds
Subscriptions                                     5.3         6.1              -        11.4
Redemptions                                      (8.5 )      (5.7 )            -       (14.2 )
Separate account flows, net                      (2.5 )      (9.2 )         (0.6 )     (12.3 )
Liquidity fund flows, net                           -           -           (2.5 )      (2.5 )
Net client cash flows                            (5.7 )      (8.8 )         (3.1 )     (17.6 )
Market performance and other                    (30.9 )      (1.1 )         (0.9 )     (32.9 )
Dispositions                                        -           -           (0.2 )      (0.2 )
September 30, 2011                            $ 144.9     $ 355.5     $    111.4     $ 611.8


The component changes in our AUM by asset class (in billions) for the trailing twelve months ended September 30, were as follows:

                                                            Fixed
                                               Equity      Income      Liquidity       Total
September 30, 2011                            $ 144.9     $ 355.5     $    111.4     $ 611.8
Investment funds, excluding liquidity funds
Subscriptions                                    18.2        25.5              -        43.7
Redemptions                                     (25.6 )     (19.2 )            -       (44.8 )
Separate account flows, net                     (12.0 )     (19.9 )          1.2       (30.7 )
Liquidity fund flows, net                           -           -           23.2        23.2
Net client cash flows                           (19.4 )     (13.6 )         24.4        (8.6 )
Market performance and other                     29.7        28.5            0.2        58.4
Dispositions                                     (1.8 )      (1.0 )         (8.1 )     (10.9 )
September 30, 2012                            $ 153.4     $ 369.4     $    127.9     $ 650.7



                                                            Fixed
                                               Equity      Income      Liquidity       Total
September 30, 2010                            $ 169.6     $ 371.6     $    132.3     $ 673.5
Investment funds, excluding liquidity funds
Subscriptions                                    25.2        24.8              -        50.0
Redemptions                                     (29.6 )     (22.0 )            -       (51.6 )
Separate account flows, net                     (11.6 )     (31.1 )         (2.5 )     (45.2 )
Liquidity fund flows, net                           -           -            0.1         0.1
Net client cash flows                           (16.0 )     (28.3 )         (2.4 )     (46.7 )
Market performance and other                     (5.5 )      12.3              -         6.8
Dispositions                                     (3.2 )      (0.1 )        (18.5 )     (21.8 )
September 30, 2011                            $ 144.9     $ 355.5     $    111.4     $ 611.8

Average AUM by asset class (in billions) for the three months ended September 30 was as follows:

                           % of                % of       %
                 2012     Total      2011     Total    Change
Equity         $ 151.3      24 %   $ 166.3      26 %    (9 )%
Fixed Income     365.0      57       364.7      57       -
Liquidity        123.1      19       112.3      17      10
Total          $ 639.4     100 %   $ 643.3     100 %    (1 )%

AUM by Distribution Channel
We have two principal distribution channels, Global Distribution and Other, through which we sell a variety of investment products and services. Global Distribution, which consists of our centralized global distribution operations, principally sells U.S. and international mutual funds and other commingled vehicles, retail separately managed account programs, and sub-advisory accounts for insurance companies and similar clients. Other consists of the distribution operations within our asset managers and principally sells institutional separate accounts and liquidity (money market) funds.


The component changes in our AUM by distribution channel (in billions) for the three months ended September 30, 2012 and 2011, were as follows:

                                                 Global
                                              Distribution          Other            Total
June 30, 2012                               $         217.5     $      414.3     $      631.8
Net client cash flows, excluding
liquidity funds                                         2.1            (10.9 )           (8.8 )
Liquidity fund flows, net                                 -              9.0              9.0
Net client cash flows                                   2.1             (1.9 )            0.2
Market performance and other                            4.0             16.7             20.7
Dispositions                                              -             (2.0 )           (2.0 )
September 30, 2012                          $         223.6     $      427.1     $      650.7



                                             Global Distribution         Other            Total
June 30, 2011                               $            222.9       $      439.6     $      662.5
Net client cash flows, excluding
liquidity funds                                           (1.7 )            (13.4 )          (15.1 )
Liquidity fund flows, net                                    -               (2.5 )           (2.5 )
Net client cash flows                                     (1.7 )            (15.9 )          (17.6 )
Market performance and other                             (22.9 )            (10.0 )          (32.9 )
Dispositions                                                 -               (0.2 )           (0.2 )
September 30, 2011                          $            198.3       $      413.5     $      611.8

For the three months ended September 30, 2012, our overall effective fee rate across all asset classes and distribution channels was 34 basis points. Fees for managing equity assets are generally higher, averaging approximately 75 basis points, as compared to fees for managing fixed income assets, which average approximately 25 basis points, and liquidity assets, which average under 10 basis points (reflecting the impact of current advisory fee waivers due to the low interest rate environment). Equity assets are primarily managed by ClearBridge, Royce, Batterymarch, The Permal Group, Ltd. ("Permal") and Brandywine, with fixed income assets primarily managed by Western Asset and Brandywine, and liquidity assets managed by Western Asset. Fee rates for assets distributed through Legg Mason Global Distribution, which are predominately retail in nature, average approximately 50 basis points, while fee rates for assets distributed through the Other channel average approximately 20 basis points.

Investment Performance
Our overall investment performance in the three months ended September 30, 2012, was generally improved compared to relevant benchmarks. While our overall fixed income strategies performance remained strong over all time periods, our equity strategies performance was, similar to many peers, less consistent against benchmarks, particularly in the shorter time periods. Index performance in the discussion below includes reinvestment of dividends and capital gains.

The equity markets ended the quarter on a positive note as markets reacted to positive housing news and the announcement from the U.S. Federal Reserve and the European Central Bank to keep interest rates low and seek to invigorate economic growth. The stronger equity markets during the September 2012 quarter resulted in an increase in all three major U.S. equity market indices, with the most notable being a 6.35% increase in the S&P 500 Index.

In the fixed income markets, economic data suggested that the recovery continued to progress at a subdued rate. With little improvement in job growth, the Federal Reserve launched a third round of quantitative easing with no explicit end-date. Investors' preference for higher returns resulted in outperformance versus U.S. Treasury investments for sectors such as High Yield.


The worst performing fixed income sector for the quarter ended September 30, 2012 was U.S. Government bonds, as measured by the Barclays U.S. Government Bond Index, returning 0.60%. The best performing fixed income sector for the quarter was high yield as measured by the Barclays High Yield Bond Index, returning 4.53%.

The following table presents a summary of the percentages of our AUM by strategy(1) that outpaced their respective benchmarks as of September 30, 2012 and 2011, for the trailing 1-year, 3-year, 5-year, and 10-year periods:

                                  As of September 30, 2012                     As of September 30, 2011
                         1-year     3-year     5-year     10-year     1-year     3-year     5-year     10-year
Total (includes
liquidity)                   80 %       83 %       79 %        92 %       59 %       83 %       53 %        85 %
Equity:
Large cap                    70 %       65 %       78 %        88 %       39 %       72 %       64 %        77 %
Small cap                     8 %       10 %       53 %        67 %       64 %       89 %       84 %        98 %
Total equity (includes
other equity)                44 %       45 %       60 %        78 %       45 %       67 %       68 %        80 %
Fixed income:
U.S. taxable                 88 %       93 %       72 %        90 %       68 %       91 %       13 %        82 %
U.S. tax-exempt             100 %      100 %      100 %        98 %        1 %        - %        - %         1 %
Global taxable               86 %       89 %       82 %        98 %       30 %       90 %       68 %        99 %
Total fixed income           88 %       92 %       78 %        94 %       50 %       84 %       31 %        81 %

The following table presents a summary of the percentages of our U.S. mutual fund assets(2) that outpaced their Lipper category averages as of September 30, 2012 and 2011, for the trailing 1-year, 3-year, 5-year, and 10-year periods:

                                  As of September 30, 2012                     As of September 30, 2011
                         1-year     3-year     5-year     10-year     1-year     3-year     5-year     10-year
Total long-term
(excludes liquidity)         57 %       56 %       84 %        73 %       67 %       80 %       76 %        74 %
Equity:
Large cap                    89 %       73 %       83 %        68 %       52 %       51 %       45 %        40 %
Small cap                    14 %       15 %       88 %        76 %       56 %       88 %       90 %        98 %
Total equity (includes
other equity)                49 %       39 %       82 %        68 %       59 %       77 %       70 %        70 %
Fixed income:
U.S. taxable                 76 %       90 %       84 %        87 %       85 %       90 %       84 %        80 %
U.S. tax-exempt              62 %       75 %       89 %        82 %       82 %       76 %       91 %        90 %
Global taxable               71 %       77 %       84 %        56 %       68 %       91 %       88 %        86 %
Total fixed income           70 %       82 %       86 %        82 %       82 %       85 %       87 %        85 %

(1) For purposes of investment performance comparisons, strategies are an aggregation of discretionary portfolios (separate accounts, investment funds, and other products) into a single group that represents that particular investment objective. In the case of separate accounts, the investment performance of the account is based upon the performance of the strategy to which the account has been assigned. Each of our asset managers has its own specific guidelines for including portfolios in their strategies. For those managers which manage both separate accounts and investment funds in the same strategy, the performance comparison for all of the assets is based upon the performance of the separate account.

As of September 30, 2012 and 2011, 90% and 89% of total AUM is included in strategy AUM, respectively, although not all strategies have three-, five-, and ten-year histories. Total strategy AUM includes liquidity assets. Certain assets are not included in reported performance comparisons. These include:
accounts that are not managed in accordance with the guidelines outlined above; accounts in strategies not marketed to potential clients; accounts that have not yet been assigned to a strategy; and certain smaller products at some of our affiliates.

Past performance is not indicative of future results. For AUM included in institutional and retail separate accounts and investment funds included in the same strategy as separate accounts, performance comparisons are based on gross-of-fee performance. For investment funds (including fund-of-hedge funds) which are not managed in a separate account format, performance comparisons are based on net-of-fee performance. These performance comparisons do not reflect . . .

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