Wednesday, January 23, 2013

Reversal of Fortune


Reversal of Fortune

Last week, Legg Mason Capital Management (LMCM) announced that it will merge with ClearBridge Advisors.  Legg Mason, the publicly traded company where I worked in the late 1990s, owns both companies.  The merger is designed to create efficiencies, as the combined entities will be able to eliminate a variety of redundancies.  This means they’re going to lay off some people and combine their back office and marketing functions.  ClearBridge has about $60 billion under management and LMCM manages $7 billion. 

The merger is filled with ironies.  Back in 2000, when I set off for Chapel Hill, LMCM had $6.6 billion under management on its way to $70 billion.  Bill Miller’s shop was growing by about 50% per year and attempting to create as much autonomy as possible.  People were clamoring to jump on the Bill Miller bandwagon.  Thirteen years later after a period of poor performance across a number of investment strategies, LMCM is back where I left it.  However, now it’s considered too small to exist on its own.

Running A Call Center (2000)

How did this come to pass?  A part of the explanation stems from bad investment performance and the bear market brought about by the credit crisis.  However, there’s another part to the story.  Back in 2005, Legg Mason swapped its brokerage business for Citigroup’s asset management division in a transaction that was supposed to transform Legg Mason into one of the world’s premier money managers.  The idea was to rid Legg Mason of those pesky brokers and the capital requirements of the brokerage business. 

I’m glad I wasn’t around when the deal was consummated; I would have been profoundly depressed to be working on a deal that I didn’t think would work. Financially, the brokerage business had long been viewed as a drag on Legg Mason’s returns and valuation.  I’d been involved in those discussions in 1998 and 1999.  However, money management and brokerage helped to reinforce one another and build up Legg Mason through its mutual funds.  The swap with Citigroup severed the relationship and with it, some of the stability in the asset management business.  Moreover, the acquisition brought any number of troubled products from Citigroup’s asset management unit.

When Legg Mason acquired Citigroup’s asset management business in late 2005, I’m pretty sure that there was no thought of merging Bill Miller’s juggernaut into a bank-owned money manager.  Citigroup’s money managers had a lot of assets and as I mentioned, a lot of performance problems.  In fact, Western Asset Management, Legg Mason’s global bond manager, took over Citigroup’s fixed income accounts.  I’m sure Bill Miller and his team made sure to keep their distance. 

Now LMCM is being absorbed by the Citigroup’s old asset management unit, which is called ClearBridge.  Although ClearBridge is significantly larger than LMCM, its assets have fallen dramatically from well over $125 billion around the time of the merger to under $60 billion today.  In other words, we’re witnessing the merger of two ailing money managers.

Bill Miller isn’t going to join ClearBridge.  Back in 1999, he shrewdly negotiated a deal with Legg Mason that gave him 50% ownership in the Opportunity Trust mutual fund.  As the fund soared to over $7 billion in assets in 2007, this arrangement paid Bill millions of dollars.  Today, that agreement gives Bill a way to keep managing money without being absorbed into ClearBridge.

Money management can be a lucrative business for those who can generate attractive investment performance.  It is also an unforgiving business for those money managers who are knocked off their perches by bad performance.  Investors seem loath to give money managers a second chance.  With the exception of Bill Miller, Legg Mason Capital Management will disappear inside ClearBridge.  If history is any guide, this move isn’t going to restore either entity to full health.

In due course, other pieces of Legg Mason will slip a way as the successful subsidiaries avoid being dragged down by the weak.  Alternatively, private equity may enter the picture and chop the firm into pieces.  The merger of LMCM and ClearBridge is juts one step down this path. 

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