Legg Mason Management Discusses Q3 2014 Results - Earnings Call Transcript

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Legg Mason (NYSE:LM)

Q3 2014 Earnings Call

January 31, 2014 8:00 am ET

Executives

Alan F. Magleby - Director of Investor Relations, Director of Communications, and Managing Director

Joseph A. Sullivan - Chief Executive Officer, President, Director and Member of Finance Committee

Peter Hamilton Nachtwey - Chief Financial Officer, Principal Accounting Officer and Senior Executive Vice President

Analysts

Christopher Harris - Wells Fargo Securities, LLC, Research Division

William R. Katz - Citigroup Inc, Research Division

Macrae Sykes - G. Research, Inc.

Daniel Thomas Fannon - Jefferies LLC, Research Division

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Glenn Schorr - ISI Group Inc., Research Division

Michael Carrier - BofA Merrill Lynch, Research Division

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Eric N. Berg - RBC Capital Markets, LLC, Research Division

Operator

Welcome to the Legg Mason Third Fiscal Quarter 2014 Earnings Call. [Operator Instructions] Please note that this conference is being recorded. It is now my pleasure to introduce your host, Alan Magleby, Head of Investor Relations and Communications. Thank you. Mr. Magleby, you may begin.

Alan F. Magleby

Thank you. On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2014 third quarter ended December 31, 2013.

This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements.

For a discussion of these risks and uncertainties, please see Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations in the company's annual report on Form 10-K for the fiscal year ended March 31, 2013, and in the company's subsequent filings with the Securities and Exchange Commission.

During the call today, we may also discuss non-GAAP financial measures. Reconciliation of the non-GAAP financial measures to the comparable GAAP financial measures can be found in the press release that we issued this morning, which is available in the Investor Relations section of our website.

This morning's call will include remarks from Mr. Joe Sullivan, Legg Mason's President and CEO; and Mr. Pete Nachtwey, Legg Mason's CFO, who will discuss our financial results. In addition, following a review of the company's quarter, we will then open the call to Q&A.

Now I would like to turn this call over to Mr. Joe Sullivan. Joe?

Joseph A. Sullivan

Thank you, Alan, and good morning, everyone. As always, I appreciate your interest in Legg Mason, and I welcome you to our third fiscal quarter 2014 earnings call. For the quarter, Legg Mason reported solid earnings and including liquidity, positive net flows for the quarter, with continuing strong flow momentum from both Brandywine and ClearBridge. This positive flows activity was partially offset by continued outflows at Royce and Batterymarch.

Long-term flows for the quarter were basically flat, and we were encouraged that our unfunded pipeline across affiliates remained strong at almost $6 billion. Our mix of business improved across asset classes as markets strengthened, and continuing to improve on our overall business mix is an area of greater focus for us going forward. Most importantly, the impact of the many actions that we've taken over the past year continued to be reflected in our financial performance and profitability. Specifically, a favorable asset and affiliate mix, improving markets and our rigorous focus on expense control has boosted our margins and, in combination with our ongoing share repurchase program, has supported the growth in our earnings per share.

In order to continue this progress, our #1 priority in 2014 is growth. We are pleased with the progress of our global retail distribution platform and remain very excited about its potential. Our distribution strategy is always going to be driven by the needs of our clients, and to that end, we are increasingly utilizing technology, client information data and segmentation analysis to better serve those needs and target clients and prospects in an increasingly efficient fashion.

While we know that we still have investment capability and product gaps, we are in a strong position today in that across our affiliates, we have products that are both in demand and performing well. And we believe that we can accelerate the introduction of new products in high-demand categories with each of our affiliates.

To that end, we hired Thomas K. Hoops from Wells Fargo to fill the critical business development position and to lead this critical effort from the executive level. Having most recently led the Affiliated Managers Group at Wells Fargo, Tom understands and is very comfortable in our diverse multi-affiliate model. And he is the perfect fit to work with our affiliates, distribution organization and executive team. Over his career at Wells Fargo, Tom has demonstrated success managing profitable growth across large organizations, developing innovative and relevant investment solutions and finding attractive acquisition candidates to expand investment capabilities.

Another important growth-related goal for us in the year ahead is to complete more management equity plans as we did last year with Permal. These plans improve our existing revenue share model, align the company more deeply with our affiliates and very importantly, afford Legg Mason the opportunity to increase its share of revenue as each affiliate grows through an incremental tiering of revenue share.

As you know, our affiliate revenue share agreements were initially set at the time of acquisition and reflected the amount of revenue that we agreed to purchase at that time. But as you've seen with Permal, we have the ability to enhance those agreements with management equity plans that are tailored to each affiliate and give their management and the Legg Mason shareholder upside as revenue and AUM levels grow. Now these are complicated agreements to amend and negotiate, but we are in constructive dialogue with our affiliates on creating such agreements and are optimistic about completing more equity plans in calendar 2014.

During the third quarter, we continued to take steps to strengthen our enterprise. We substantially completed the wind down of Esemplia, which we have previously disclosed, and we moved our internal audit function to a co-sourcing arrangement with a top accounting firm, both as part of our continued focus on running an efficient and effective organization. As you saw recently, we refinanced our debt, deleveraged our balance sheet and locked in long-term debt capital at current historically low rates. Since we generate a significant amount of cash and we retain most of that cash as a result of our tax shield, we have both the ability and intent to invest strategically in future growth, which is the foundation of building a better Legg Mason, and I believe that we are well on our way to doing just that.

Now let's walk through our financial and operating results for the third quarter. Slide 3 shows highlights from the quarter just ended. We reported net income of nearly $82 million or $0.67 per diluted share. As you may remember from our pre-announcement, these earnings include a return to a normalized effective tax rate in the U.K. and severance costs related to the closure of some businesses and other restructuring costs, about which Pete will provide more details shortly. These results also include a charge to increase the contingent payment liability related to the Fauchier transaction as the business has actually performed better than initially projected. This kind of earnout structure, which provides additional upside for strong investment and operating performance, is a win for Legg Mason and its shareholders and is exactly the kind of contingent payment we are very happy to make.

In keeping with our commitment to return capital to shareholders, we purchased 2.3 million shares for $90 million while maintaining a cash position of approximately $800 million. And I'm pleased to report that 80% or greater of our strategy AUM continues to exceed benchmarks for all periods.

Slide 4 is our standard presentation of AUM by affiliate. As we've reported, we experienced net inflows for the quarter, driven by liquidity, with long-term flows flat for the period. As I stated earlier, our primary focus as we begin calendar year 2014 is to build upon the improvement that we've made the last 12 months to grow and meaningfully increase our net long-term inflows.

Now let me provide some commentary by asset class, starting with fixed income. Western Assets net inflows for the quarter were driven largely by liquidity, while long-term flows were close to breakeven. Inflows into specialized mandates during the quarter were more than offset by outflows from broad market strategies and municipal products. Won, but not yet funded, mandates at Western stand at $2.9 billion, and the company's finals presentations continued to trend upward as strong investment performance continues.

Western participated in 20 finals presentations during the quarter for a total of 108 finals presentations in 2013, up 35% from 2012. Western and our corporate product teams launched both a Macro Opportunities and a Senior Loans Fund while Western extended their active ETF business with WisdomTree. Western continues to see significant interest in unconstrained, absolute-return and short-duration products from both institutional and retail clients, a trend we see as sustainable and a wonderful opportunity to capitalize on the breadth of Western's investment expertise and capability.

Brandywine Global recorded over $1 billion in inflows for the quarter, and the company's total AUM closed December at just over $50 billion, an all-time high. Brandywine's won, but not yet funded, mandates remained strong, closing the quarter at nearly $800 million. Brandywine is seeing solid wins across both fixed income and equity strategies, notably as the company's long-term equity performance numbers are improving. While many still think of Brandywine as predominantly a fixed income shop, the reality is that their origins are actually that of a value-oriented equity firm.

To that end, Brandywine's pipeline for their large-cap value product is the highest it has been since March 2007. Brandywine experienced some short-term fixed income underperformance for the quarter, specifically related to emerging market exposure. However, the company's performance versus benchmark remains quite strong across longer periods.

In the U.S., Legg Mason and Brandywine launched the Brandywine absolute-return credit fund, and we expect to launch a UCITS version of their global macro fund in the first half of 2014. Brandywine, like Western, continues to see an opportunity in global, unconstrained and absolute-return products. And the strong capabilities at both firms to deliver these types of strategies is why I really like how we are positioned during this period of transition in the fixed income space.

Now on to equities. Strong momentum in equities at ClearBridge Investments was offset by some continued flow weakness at other affiliates. ClearBridge had broad-based inflows in excess of $2 billion, marking the fourth straight quarter of net inflows for the firm. Net inflows were led by high active share products, in particular, ClearBridge Aggressive Growth and ClearBridge Small Cap Growth. Won, but not yet funded, mandates for ClearBridge at the end of the quarter stood at $1.2 billion.

Very importantly, ClearBridge continues to diversify its business by distribution channel, by client type and by geography. As many of you will recall, at the time we acquired them, the book of business at ClearBridge was highly concentrated with a single distributor. Now while those concentrated legacy relationships in the warehouse channel remain strong and very important, ClearBridge and our retail distribution teams have significantly diversified that retail book of business, with more than 2/3 of their retail AUM in the U.S. now in other expanded relationships across the national broker dealer, RIA and independent advisor channels. And at the same time, ClearBridge continues to work with our international distribution team, developing their business in Europe and Asia.

ClearBridge has strong performance across a number of funds, and consequently, we feel very good about the ability of ClearBridge to pivot as demand dictates to additional products with strong performance in the year ahead. We are set to complete the final step in the combination of Legg Mason Capital Management into ClearBridge Investments in February, at which time, we will rebrand the entire Legg Mason Capital Management entity with the ClearBridge name.

The Legg Mason Capital Management team, led by Sam Peters, has integrated very well with the investment team at ClearBridge. And this initiative will be an important step in building an even stronger brand around their shared fundamental stock-picking orientation. The ClearBridge story over the past 5 years or so is really a terrific blueprint for how Legg Mason and affiliates can work together to diversify and grow the business.

Outflows at Royce ticked up slightly during the quarter as redemptions increased at year end, and new subscriptions continued to be below historic levels for the company. On the positive side, we are pleased that inflows on the international side of the business continued to grow, with positive net flows internationally in every quarter of 2013. That said, Royce's relative performance over the last couple of years has certainly suffered against the backdrop of an extremely strong market with the benchmark Russell 2000 being up 37% this past year. Importantly, though, in absolute performance, Royce continues to be quite positive, with 3 of their top 5 strategies in terms of AUM posting 1-year returns of 30% or more.

Chuck continues to believe that their investment focus on quality companies should perform well as we move into a more normalized interest rate environment, and investor sentiment shifts from such a focused search for income and yield back to fundamentals and total returns. Realistically, some of their products will need time to recover relative investment performance in order to screen better on advisor databases. However, Royce is aggressively playing offense with our distribution partners, with a focus on their rolling investment returns, which continue to show that their style of active management adds value across market cycles.

Royce is working very closely with our Global Distribution teams and has added new sales resources internally, with an eye to add even more in 2014. Royce's positive absolute investment performance, along with very favorable small-cap markets, has resulted in assets under management at Royce that have an increase by more than $4 billion year-over-year and $1 billion quarter-over-quarter, with corresponding increases in revenue that allow for Royce to continue to invest in its franchise.

Batterymarch, at $10.7 billion, is down marginally from last quarter. And while Batterymarch did experience continued outflows in the quarter, they continue to work with clients to develop customized strategies designed to address specific investment objectives. The firm was recently awarded a new managed volatility mandate that is due to launch in the second quarter of 2014.

Moving on to alternatives. Permal delivered strong absolute and relative investment performance during the quarter at both legacy Permal and in the Fauchier Partners business that we acquired last year, all of which drove higher calendar year-end performance fees. Permal remained an outflow at roughly the same level as last quarter as inflows into the U.S. institutional business and the Middle East were offset by some lumpy outflows from global distributors in European institutions.

Permal still sees good opportunity in their expanded institutional platform in Europe. Important wins in the quarter included new mandates across their customized managed account business. The Permal Managed Account Platform now has $8 billion across 86 client accounts and is state-of-the-art in terms of the evolution of the business to more customized mandates increasingly in demand by institutional clients. Additionally, Permal opened a Beijing office. China has been a major focus and investment for Permal, so we were excited about seeing some momentum in that strategic market.

Permal's unfunded wins at quarter end were approximately $700 million. Permal continued to drive robust new product development as they launched their activist fund with $60 million and placed some retail products on distribution platforms in the U.S. We continue to believe that the U.S. retail marketplace offers significant opportunity for Permal, and we hope to launch Permal's daily liquidity fund soon.

Certainly, there are many challenges that most alternatives and fund-of-hedge fund managers face, including outflows in European high-net worth channels and increasing direct competition from investment consultants. Going forward, however, we believe that Permal is well positioned to capture growth opportunities through 3 key trends: first, a projected increase in longer lock allocations by institutions; second, the continued demand for customization in the hedge fund space; and third, the ongoing march to bring alternatives to the retail market through public vehicles, both with longer-term and more liquid structures.

Slide 5 shows investment performance. And as you can see, strategy AUM performance versus benchmark has continued to remain strong across all time periods. Performance versus peers at calendar year end is more mixed, reflecting underperformance versus peers across a handful of large individual funds at Royce, ClearBridge, Western and Brandywine. Some of that 1-year underperformance has reversed in the month of January.

Slide 6 focuses on Global Distribution. As we look at our results compared with last year, we continue to see the payoff from ongoing investment in our retail distribution business across geographies and channels. Fiscal year-to-date, we saw growth in gross sales in every channel we serve and every region in which we operate, with the exception of Japan, which matched its robust sales in the same quarter a year ago. We've seen time and again that our diversification and distribution allows us to balance cyclical softness in certain regions and channels with strength in others.

Specifically for the quarter, we achieved gross sales of $17.2 billion across the platform, the highest level since March 2007. With gross sales of nearly $50 billion fiscal year-to-date, we are running at a 22% increase in gross retail sales year-over-year. Net flows in our retail business were positive, $1.7 billion in the quarter, driven by positive flows in our international distribution business and flat net flows in the U.S.

ClearBridge and Brandywine products led the net inflows, while outflows continued to be driven largely by equities at Royce and Western Muni. Internationally, we saw positive inflows across 4 key affiliates: Western, ClearBridge, Royce, and Brandywine, and positive net flows in 3 of our 5 regions. Continuing to grow retail distribution remains a critical focus for us. And to that end, we are building out our sales and CRM systems globally, as well as collaborating with our distribution partners to segment their advisor bases across all of our regions. In a number of specific instances, using the data that we have received and developed, we have targeted specific advisor segments to identify products that suit a specific need and create a focused campaign around it. We intend to expand that type of highly informed marketing effort aggressively.

As we look to the new fiscal year, we will continue to work with our distribution partners to expand those relationships, provide additional training, utilize marketing and thought leadership campaigns, match existing products to current client needs and, where appropriate, introduce new products to address the future investment objectives of our clients.

And with that, let me turn it over to Pete now to discuss the financials.

Peter Hamilton Nachtwey

Thanks, Joe. Turning to Slide 7, I'll start with the financial highlights for the quarter. We generated earnings of $82 million or $0.67 per share, which is within the range that we announced prior to our debt offering earlier this month. As we announced, the strong results for the quarter resulted from higher performance fees, along with an improved product and affiliate revenue mix. So we had a very strong quarter despite the $12 million in costs related to our streamlining initiatives, as well as a $5 million increase to our contingent payment liability related to Fauchier.

With regard to the efficiency initiatives, our actual expenses of $12 million came in slightly lower than expected for the quarter due to timing issues. Looking forward to fiscal Q4, we are anticipating additional costs in the quarter of approximately $4.5 million, while the net annual run rate savings for the initiatives we've identified to date should hit $11 million.

Adjusted income was $125 million for the quarter or $1.03 per share, which includes the impact of the severance and other initiative costs. Average AUM in total was up 3% from the prior quarter, with average equity up 6% and average fixed income up 1%. Operating revenues were up 8% from the prior quarter due to a significant increase in performance fees, as well as a 3% increase in advisory fees reflecting the higher average AUM. This quarter's total performance fees of $51 million were primarily from Permal and include performance fees on Fauchier products, which predominantly have December 31 annual lock dates.

In addition, we realized performance fees from Brandywine and Western during the quarter. While impossible to predict with any precision, we estimate that next quarter's performance fees should be in the range of $10 million to $20 million, subject to market movements as there are fewer products with annual locks outside of the December quarter.

On the balance sheet front, this quarter, we repurchased an additional 2.3 million shares for $90 million. Going forward, we continue to anticipate share repurchases of $80 million to $90 million per quarter, as always, subject to markets and/or growth opportunities. This is consistent with our plan to use up to 65% of our operating cash flow for share buybacks.

Moving on to Slide 8. The only item to highlight here is our GAAP effective income tax rate of 36.5%, which is slightly higher than our prior run rate due mainly to the Fauchier contingent liability increase and other adjustments made in finalizing prior fiscal year tax returns. We are forecasting our effective GAAP tax rate for fiscal Q4 to be around 35% subject to final state apportionments as we file our remaining fiscal 2013 returns. For now, we are not changing our guidance for fiscal '15. But most importantly, as you will see on a later slide, our actual cash taxes continue to run at a substantially lower level than our GAAP rate.

Turning to Slide 9. Our assets under management were up 4% from the prior quarter mainly due to market increases of over $14 billion, which were net of nearly $4 billion in foreign currency movements. In the quarter, equity as a percentage of total AUM increased to 27% while fixed income assets dropped to 52%. Overall, the increase in AUM was due to positive equity markets and liquidity inflows.

Long-term flows on Slide 10 were break-even for the quarter but much improved from the prior quarter's negative flows. Fixed income inflows for this quarter were $700 million compared to inflows of $300 million in the prior quarter. This reflects a pickup in institutional mandates of both Brandywine and Western. Equity outflows declined to $700 million from $4 billion last quarter.

This quarter's improvement was primarily driven by inflows at ClearBridge and Brandywine, while Batterymarch's outflows abated somewhat. These factors combined to help offset a pickup in outflows at Royce. As a reminder, last quarter's results also included $700 million in outflows related to the Esemplia wind-down.

On the liquidity front, inflows were almost $10 billion. And as we look forward to April, I want to highlight that again, this year, we expect to have a liquidity redemption in the $10 billion to $15 billion range relating to a sovereign client with the ultimate amount dependent upon their quarterly cash needs.

Slide 11 shows the advisory fee trend, with this quarter's rate basically flat from last quarter, reflecting retail and high net worth outflows at Western and Permal, respectively, with inflows into somewhat lower-fee institutional mandates. Average long-term AUM increased 3%, and within that move, average equity assets were up $10 billion, and average fixed income assets were up $5 billion.

Operating expenses on Slide 12 increased to $598 million from $563 million last quarter. I'll discuss comp and benefits on the next slide, but as to the other components, distribution and servicing expenses decreased $6 million from the prior quarter, primarily due to a $3 million adjustment in distribution partner accruals and the impact of $2 million in closed-end fund structuring fees last quarter.

Occupancy expenses increased as last quarter's results included a credit related to reserves for excess space. The other expense increase of $7 million was largely driven by the $5 million increase in the contingent payment liability for Fauchier, which reflects earnings levels higher than we expected at the time of the transaction. In other words, a very positive event, but one that yields a somewhat counterintuitive accounting charge.

Turning to Slide 13. Compensation and benefits increased overall by $28 million. The primary driver was higher revenue share-related compensation due to the 8% increase in operating revenues. In addition, severance related to the previously disclosed corporate efficiency initiatives increased slightly from the prior quarter. The resulting 54% compensation to net revenue ratio is a bit lower than our typical range of approximately 55% to 56%, reflecting the affiliate revenue mix.

Slide 14 highlights the operating margin as adjusted, which increased to 24.1% from last quarter's 22.3%. The higher margin was due to significantly higher revenues, reflecting the annual calendar year-end performance fees. The increase in performance fees quarter-over-quarter also increased our margin by approximately 2 percentage points. Going the other direction, severance and other costs related to our efficiency initiatives had a negative effect. These costs reduced our margin by approximately 2 percentage points.

Last quarter's operating margin included costs related to our efficiency initiatives, partly offset by the occupancy credit. These reduced the operating margin as adjusted by 1.5 percentage points. Looking ahead to next quarter, our margin will be influenced by the fact there will be 2 fewer days in the quarter, resets of certain payroll tax and employee benefit rates, as well as lower anticipated performance fees.

Slide 15 is a roll-forward from fiscal Q2's earnings per share of $0.70 to this quarter's $0.67 per share. Fiscal Q2 had $0.05 of charges related to various corporate items, including the previously discussed efficiency initiatives, the loss on the sale of PCM and positive occupancy credits. The quarter also included the U.K. tax benefit of $0.16. These 2 factors combined for an $0.11 impact last quarter. The current quarter included the ongoing efficiency initiatives and the Fauchier contingent payment, which, together, also totaled $0.11.

Finally, changes in net revenues and expenses, along with share repurchases for the second quarter, increased earnings per share by $0.17 with the primary driver being the seasonally higher performance fees, along with higher average AUM.

On Slide 16, you can see that our effective tax rate for the quarter was approximately 36%, and the forecast for the full year is for a 31% effective tax rate. But the key, once again, is our cash taxes, which continue to run at 4%. We currently expect the cash tax rate to remain in the 4% range for fiscal 2015 and under 10% until we become a U.S. federal taxpayer again, which we currently project to occur early in the next decade.

This low cash rate allows for both additional investments in the business and additional return of capital to shareholders. As a reminder, this low rate results from our NOL carryforward and our ability to amortize goodwill and indefinite-lived intangibles for tax purposes, but which are not amortized for GAAP. When you translate our cash tax rate into estimated dollars saved, which are on the right side of the schedule, you see that over time, we anticipate realizing a total cash savings of $1.4 billion.

I'll wrap up on Slide 17, which highlights a number of balance sheet items, including how those have changed, thanks to the successful debt deal we announced 2 weeks ago. In the upper left, you can see that we have reduced our share count by 42 million shares or 26% over the last 4 years, and we still have $460 million of board-authorized repurchases remaining. In the upper right, we've highlighted our cash position over the last several quarters, and you can see that as of December 31, our cash level increased to over $800 million.

Also, as you recall from the announcements around our successful offering of $400 million in 30-year notes, we paid off the entire bank term loan of $450 million, which would have matured in 2017. To accomplish this, we used the proceeds from the new 30-year notes, as well as cash off the balance sheet, meaning we effectively delevered by an incremental $50 million.

In the bottom left, you can see our new debt structure, which now includes the $400 million in 30-year debt with a 5 5/8% coupon rate and which was significantly oversubscribed at the offering. This new debt will increase our annual interest expense by approximately $15 million, a price, we think, is well worth the benefit of derisking our balance sheet and expanding our base of debt investors.

Finally, on the capital front. We are working to increase the size of our undrawn bank revolving credit facility by $250 million to a new total of $750 million. This, along with the excess cash on our balance sheet, provides us with substantial dry powder to invest in the business.

So to sum up on this slide, we have returned capital to shareholders, both through dividends and share repurchases, while maintaining our sizable cash position, thanks to strong operating cash generation. And we have significantly improved the liability side of our balance sheet over the past few years with 2 debt transactions that allowed us to extend maturities in both instances and delever by a combined $450 million.

So thanks for your time and your interest in Legg Mason. And now I'll turn it back to Joe.

Joseph A. Sullivan

Thanks, Pete. As we've discussed this morning, we are pleased with our progress this quarter regarding net flows, business mix, cost control and the resulting positive impact on our financial performance. But stepping back, I think it's important for investors to understand that our focus is on not just sustaining but accelerating that progress, and not only in calendar 2014 but over the longer term.

This includes constantly evaluating and optimizing asset, client and affiliate diversification while investing in high-demand categories and products. It also includes investing in our global distribution platform and capabilities that we believe will yield AUM growth by segmenting investor clients, focusing on their needs and delivering positive results for them. Enhancing the structure of our affiliate model will also play a part in our growth and success, and we're optimistic about completing additional management equity plans in 2014 that not only better align affiliate and parent, but in so doing, position Legg Mason shareholders for greater leverage as revenues and AUM grow.

Finally, rigorous expense control will always be part of how we manage this business. And taken together, we believe these factors will allow for margin expansion and sustainable earnings growth over the coming years. And we look forward to reporting further on our progress to that end.

And with that, we'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Chris Harris from Wells Fargo Securities.

Christopher Harris - Wells Fargo Securities, LLC, Research Division

So we're -- appearing from a number of your competitors that retail investors are really starting to rerisk here and get back into equities, and we're obviously seeing this in stronger equity flows industrywide. I guess, there's a market perception that's out there that institutions might follow retail investors down that path. And just wondering, guys, in your conversations with Western, are you hearing that at all? I mean, basically, it sounds like from your prepared remarks, there's more like a rotation happening within fixed income and not out of. But maybe just curious to see if you guys can kind of comment on that a little bit more and why institutions might kind of diverge from retail investors.

Joseph A. Sullivan

Good morning, Chris. Couple of thoughts on that. Number one, I think sort of that rotation within fixed income is clearly a theme that we have seen and are experiencing and we've talked about over the last few quarters. Both Brandywine and Western are seeing more investors looking for, as we've talked about, unconstrained and absolute-return products and moving into those in greater -- to a greater degree. As it relates to the equity side, we haven't specifically heard that more of the institutional side are rerisking per se. And as we've talked about before, many clients that have specific allocation requirements have to top up, particularly as fixed incomes becomes cheaper relative to the equity markets. In fact, we are experiencing some clients that are forced to kind of add to their allocations to fixed income. That said, on the equity side institutionally, we are seeing good interest both particularly at ClearBridge and more recently, at Brandywine with some of their core strategies and key strategies. So we're pleased with our capabilities as it relates to equities and the appeal to institutional investors, but we haven't heard a specific key theme about a rotation into equities from the institutional side.

Operator

Our next question comes from Bill Katz from Citi.

William R. Katz - Citigroup Inc, Research Division

Okay. First question, Joe, you sort of talked a little about some more adjustments for the revenue share model. Could you potentially talk about the timing when you might see some news on -- we might see some news on -- hear some news on this? And then within that, which affiliates are you working with? And how should we think that -- think about that from an earnings perspective?

Joseph A. Sullivan

Bill, I think that we are close -- I think what you're referring to are the management equity plans. And that -- those really are opportunities for us to ultimately gain incremental -- an incremental tiering of rev share as they grow. Remember, these are growth unit-type plans, so it's as they grow that the shareholder can experience incremental tiering of rev share. We are -- I don’t think it would be good for me to get into the specific affiliates. But I can tell you that we are -- I think fairly, we're very close with one, I think we're fairly close with another, and we're in a dialogue with virtually all the other affiliates on these plans. They just take time. Unfortunately, they're complicated documents. We have to kind of tailor them to each and every affiliate, so they're a bit nuanced. So they just take time. But I will tell you, I think we're very close with one, we're reasonably close with another, and we're at various stages of negotiations with the rest.

Peter Hamilton Nachtwey

And, Bill, it's Pete. On the financial statement impacts, as you saw with Permal, and we've talked about that as more or less a template for the majority of our affiliates, the accounting charge at the end of the day is relatively de minimis. It was roughly $10 million for Permal spread over 4 years. But then they're paying for half of that out of their bonus pools. So effectively, it's cash-accretive immediately and only marginally dilutive to GAAP earnings. And the only thing that would vary from that would be if we ended up monetizing. Some of the current rev share could result in a bit of a different accounting construct, but that would be a potentially good deal for the shareholders to be able to acquire some of the existing rev share.

Operator

Our next question comes from Mac Sykes from Gabelli.

Macrae Sykes - G. Research, Inc.

We've seen some management changes at one of the largest fixed income competitors. I was wondering if you could talk about Western's and Brandywine's ability to take share. And what exactly might be the opportunity in the near term?

Joseph A. Sullivan

Well, I think that -- I don’t know that there's going to -- that we should create an expectation that because of that management changes, we're going to have a significant increase as a result of those in our market share. I think that what should drive the increase in our market share is focusing on investment performance. And if you look at what Western's done, their numbers are just spectacular over the last 5 years in particular and longer term. They've really recovered since the depths of the crisis. And the -- and their investment performance is outstanding. Same thing with Brandywine particularly on the global op side. Again, their 3- and 5-year numbers are just really strong. And so that should be the driver of increasing our market share. We don't really think about necessarily one person leaving being the opportunity. We think we have to earn it with investment performance.

Operator

Our next question comes from Dan Fannon from Jefferies.

Daniel Thomas Fannon - Jefferies LLC, Research Division

Looking at your fee rate, I look at your asset mix equities are essentially at a 3-year high. And you talked about this shift within Western, which appears to still be towards higher-fee products. Can we talk a bit more about that -- the outlook for your fee rate, assuming flat markets and based on where you're seeing demand and how you think that can trend over the next 12 months?

Peter Hamilton Nachtwey

Sure, Dan. It's Pete. I guess, a couple of things to note there. Number one, the fee rate is up nicely in a year-over-year due to the trends around client mix and asset mix. I think in the short term, over the last quarter, what we saw was a little more strength in the inflows on the institutional side, particularly at Western and, to a degree, Permal, and some outflows or slowdown and inflows on the retail side, particularly at Royce. So those factors, any individual quarter can bounce around a little bit, particularly when we're slicing the salami pretty thin, showing a 34.2 bp kind of number. So it could bounce around a little bit. But over time, it's going to be a mix of both clients and product, both clients and asset class and then product within that. So we do think the overall trends of specialized mandates on the institutional fixed income side and as clients rerisk and move into more in the equity products that those trends clearly should help us as well as alternatives.

Joseph A. Sullivan

And I think, Dan -- this is Joe. To the extent that we're successful on the M&A side or in bringing in additional investment capabilities, clearly, we're focused more in areas that would elevate that fee rate over time. So as Pete said, you're going to have bounces because we're diversified. And I actually -- it's part of the strength of what I think is Legg Mason. We have a very diversified book of business. We are diversified by asset class, diversified by client type, diversified by geography. And all of that, as Pete talks about, comes into the mix in any given quarter. But long term, we're focused on increasing that fee rate and doing so really by adding additional capabilities in higher fee rate areas.

Operator

Our next question comes from Michael Kim from Sandler O'Neill.

Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division

So I just wanted to follow up on the rerisking dynamic. Assuming retail investors continue to move up the risk curve, just curious how you see that playing out as you look across your affiliate base. So would expect some affiliates would benefit more than others, but just net-net, how do you think that might impact the overall flow profile of the firm?

Joseph A. Sullivan

Well, Michael, I -- one of the ways I think about it is there is -- we talked about this a little bit on an earlier question. There's a bit of a rerisking going on, even within asset classes, right? So on the fixed income side, and this is the case both on the institutional and retail side. There's a bit of a move away from sort of off-the-shelf products into products that are more unconstrained, absolute-return. Those tend to be attractive to us from a couple of standpoints, both institutionally -- and particularly institutionally, I think, but also on the retail side. They tend to have a bit higher fee rates. It can vary depending upon the specific mandate, but typically, they have a bit higher fee rates. And secondly, particularly on the institutional side, and I think this is a point that's missed sometimes, I think this move -- this kind of rerisking and movement towards more customized mandates is a real positive and has the potential to be a real positive from the standpoint of persistency. What we find on the institutional side is that when a client comes to us and wants us to -- wants to customize a strategy or mandate, they become much more invested in the strategy itself because they've helped -- worked with our teams to actually create it. And they ultimately, I think, are more invested and committed to it. So I think rather than just an off-the-shelf product that, quite frankly, is easier to just redeem if things aren't going quite so well, they've helped to actually construct these products. Kind of the same thing, I think, on the retail side. So when we work with -- as we are working with our distribution partners who want sort of alternative fixed income products, for example, those are going to typically, I think, have higher fee rates. But also, we're going to be working in collaboration with those distribution partners to really customize those strategies for their advisors and their clients. And so I think the potential is for those specific strategies to have greater persistency over the long term. This move, certainly a rerisking move. We feel good about the equity products we have. We've got some very good sort of concentrated and high-conviction products at ClearBridge and at Royce. We feel good about the equity products that we have, and as you can see and as you have seen, we're capturing an awful lot of share particularly at ClearBridge on the equity side.

Operator

Our next question comes from Robert Lee from KBW.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

So my two questions here. First one is I'm just curious, when you look at the product development at Brandywine and Western on the fixed income side, I mean, clearly moving towards more unconstrained, absolute return, maybe global strategies in the mix. How do you, from distribution perspective, choose which product you're going to distribute? I mean, how do you kind of weigh access to your -- the Global Distribution platform when they're both, I guess to some degree, maybe developing new products in the same category? Or isn't that the case?

Joseph A. Sullivan

Sure. Rob, there's a couple of thoughts there. One is obviously, the primary and the first and foremost driver of what our distribution platform and our teams are focused on are what clients want and what clients need. So that's where we start. The good news, I think -- you highlighted kind of potential conflicts of similar products between Western and Brandywine. And the reality is while they have products that, to the naked eye, might appear to be very similar or even identical, they're really not. The way Western manages assets and the way Brandywine manages assets is very different and, we think, actually complementary. So if you look at Western, Western is really -- if we're just talking about their core business, Western is really a bottoms-up credit selecting type of manager. They're very good at it. Their performance shows that over a long period of time. Brandywine really doesn't do that at all. Brandywine is much more of a top-down, sovereign-selecting currency overlay manager. So they're very, very different, both in how they would manage global products -- or Brandywine really doesn't manage a lot of U.S. products. But that overlap would probably be more in high yield and more in the global space, but their investment theses and philosophies are very different and, frankly, complementary. We can very comfortably speak with an advisor about diversifying with 2 different approaches on a global fixed income product and recommend and, in fact, get sales in both products. So we don't find it to be a huge conflict.

Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division

Great. And maybe this is a follow-up. How should I think of the -- maybe an incremental earnings impact assuming Royce continues to be challenged from a flow perspective, and ClearBridge is clearly on a strong path. But even though maybe Royce products will have a higher fee, there's a revenue share, whereas ClearBridge, still healthy fee but maybe not as high as Royce, but it's not a revenue share affiliate, if I remember correctly. So is really the incremental margin kind of similar between the 2? Or is that really not the right way to think of it?

Peter Hamilton Nachtwey

No, I think couple of things there. One, Royce is actually one of the highest levels of AUM that they've ever had, helped along by the market. So despite the fact their relative performance may be challenged, 3 of the 5 products -- the 3 of the 5 largest products that they manage actually had absolute returns last year in excess of 30%, but we're still slightly behind their benchmarks. And the reason for that is they don't chase the -- kind of the marginal companies that are benefiting tremendously from this low rate environment. So Royce is actually, from profitability standpoint, both in their bonus pooling for us, is actually up. And then ClearBridge, their -- it's nuanced in terms of their relationship but effectively operates like a rev share. We refer to it as a margin target. But for all intents and purposes, it's the same. But obviously, they're benefiting tremendously from this rerisking move of retail into equity. But more importantly, their performance has been outstanding, and it's in the products that really right now are in greatest demand. So you've really seen a big uptick in their AUM.

Joseph A. Sullivan

And I think just to piggyback a little bit, Pete, ClearBridge has been a bit of a pioneer in the closed end space, particular around MLPs, and they've developed a real specialty and expertise in that space. And that business is very attractive to us, very high-fee business and very persistent business because it's effectively permanent capital.

Operator

Our next question comes from Glenn Schorr from ISI Group.

Glenn Schorr - ISI Group Inc., Research Division

Quick question for you, Pete, on -- so you've done great with the buyback. Share count's down like 8% and the stock's up a ton. Looking for a little refresher on how you think about ROI on that going forward on buybacks. And I guess while we're on the topic, in a better case, in reverse order, as acquisitions go into the new business development, how you -- remind us again how you think about financial [indiscernible] on the way in?

Peter Hamilton Nachtwey

Yes, let me speak to the buyback, Glenn, and then I'll maybe hand it to Joe in terms of talking about acquisitions and how we're thinking about it. But bottom line is we're very pleased with how the stock has performed. We're not surprised because as we've been saying all along, we think there was a significant amount of value that wasn't being recognized by the marketplace. And hopefully, we've done a better job at telling the story. I think Joe has done a very good job of making sure we're more transparent, helping all of you and the buy side understand the dynamics in terms of valuation for our firm. But having said that, you've heard us talk a lot about EBITDA, enterprise value EBITDAs, the way these firms typically are valued, particularly on an M&A context. And that's really how we think about that for a buyback perspective. And while our stocks had a nice run-up, so has the group. And so we still see ourselves being below probably by 2 to 3x turns of EBITDA in terms of valuation. So we continue to be buyers of the stock, and the board is very supportive of that.

Joseph A. Sullivan

Glenn, I -- a couple of things I think about. First of all, in terms of your question to Pete around effectively a cash usage question, we've got plenty of cash, as we talked about earlier, about $800 million in cash. And we've got a revolver that's wide open. So we've got plenty to fund any acquisitions that we see on the near-term horizon. I will tell you just what's the activity like. I mean, these things just take a lot of time. But I can tell you that I don't think Jeff Nattans, who's our head of M&A, has been busier -- has been as busy as he is now in years, if ever, at Legg Mason. There's just a lot of stuff that's coming in across the transom that we get an opportunity to look at. As you would expect, most of what we see doesn't fit or doesn't work. But there are some things that are of meaningful interest to us. We know exactly where we need to fill holes, and we're working very, very actively on it. As I've said before, I work on M&A broadly virtually every day in one way, shape or form. And these things just take time. It tests my patience. And I know everybody would like to see it. But I think we'll have some opportunities as the year plays out, and I'm excited about them.

Peter Hamilton Nachtwey

You may -- I might just expand a bit, too, in terms of what we refer to as dry powder. But if you look at the -- sort of in terms of what we have available to deploy to do deals. And today, we've got over $400 million of excess cash on the balance sheet. We've also got $500 million completely undrawn on the revolver. And as I mentioned earlier, we're in process virtually almost finalized on expanding that revolver up to $750 million. So we have an ability to readily draw in over $1 billion worth of liquid resources if we see a deal. And on top of that, we can slow the buyback down. So if we do see something that's more interesting from a long-term growth perspective, and particularly things that can fill the product gaps and leverage our global distribution capability, we'll slow the buyback down and maybe turn it off. And as you probably know, these deals take probably 6 months from the time you get a signed term sheet before we actually get to closing. And then the other place where we're using capital is seed. And we've been able to seed a significant amount of new products simply by recycling, and we've been much more aggressive, our capital committee, and making sure that we're wisely utilizing that seed capability. So we've seeded close to $100 million worth of new products over the last year with a minimal amount of incremental cash. But if we see, again, some really interesting opportunities, we could have an uptick in that area as well.

Operator

Our next question comes from Mike Carrier from Bank of America Merrill Lynch.

Michael Carrier - BofA Merrill Lynch, Research Division

Maybe just a question on the margin and probably a little bit for Pete and a little bit for Joe. So if we look at year-over-year, you've got -- like the improvement has been pretty consistent and pretty impressive. So I guess, Pete, just for you, so we kind of understand the put and takes, on the 24% this quarter, just want to make sure when I -- if I'm understanding it right, in terms of the performance fees, would be benefiting that by, I think, you said 2%. But the severance in the Fauchier charge was offsetting that. And so net-net, should we be thinking like a 24%? It looks like a pretty good rate. Obviously, first quarter, fewer days, comp expense, the normal stuff that's going to impact that, but in terms of, like, a pretty clean number. And then just for Joe, maybe just in terms of the outlook, I guess as long as that mix continues with ClearBridge, then you continue to have that kind of going in your favor. I guess just from a -- you mentioned growth in 2014 and '15. Is there anything specifically that you feel like from an expense standpoint that would be picking up? Or are a lot of these things kind of ongoing, you guys have been investing in distribution, and it's just more executing and then realizing some of the improvement on the flow side?

Joseph A. Sullivan

So, Mike, just a quick comment on your last question, and then I'll turn it over to Pete. We have taken -- we have continued to take a number of initiatives, which we've been talking about for the last few quarters. I mean, we're wringing out every dollar of excess expense that we can, and then we really make decisions around that in terms of how much we're going to repatriate back to shareholders and how much we're going to invest in the business. And we are -- we do have dollars sort of set aside to invest in the business. We see opportunities to invest in -- particularly in distribution. We can get better there and improve just on a productivity basis. But we can also expand distribution. We run a very tight ship in distribution, so we're proud of that. But we think we have opportunities to expand there. We create the investment dollars through some of the other savings that we've generated. As it relates to the walk-through and the margin, Pete, I'll let you.

Peter Hamilton Nachtwey

Sure. I can actually -- Michael, you did a very good job at parsing through it. But indeed, performance fees, the -- they call it the excess performance fees that we got in the December quarter due to the annual locks were in the 2% range. In terms of impact on the margin, that'll be 2 percentage points. And then the cost of our initiatives virtually exactly offset that. And then as we think about it going forward, Q4, you mentioned some of the factors. But to kind of run through all of them, there's really 2 sets of resets: the social taxes or payroll taxes that'll kick in starting at the beginning of January, as well as some resets on our employee benefit plans. And then there's also 2 less days this quarter. And as you know, we get paid effectively on a daily basis. And then last but not least, performance fees, we don't envision being quite as high, actually significantly lower in the next quarter. And that depends on markets. So as of right now, we gave some guidance, but that's going to be heavily dependent on markets. But the other factors, the fact that December 31 ends up being a very high watermark quarter just due to the number of annual locks. And that's now going to be an even bigger trend going forward with Fauchier because the majority of their products are December 31 locks.

Operator

Our next question comes from Marc Irizarry from Goldman Sachs.

Marc S. Irizarry - Goldman Sachs Group Inc., Research Division

Great. Joe, on your comments, you mentioned, on ClearBridge, that you're prepared there for pivoting to additional products. I'm curious specifically, where -- what are some of those areas where you see the additional product opportunities for ClearBridge? And then also when you think about multi-asset class maybe within where people are going to pivot, how does -- how do the different affiliate relationships play into products on the multi-asset class side?

Joseph A. Sullivan

So, Marc, I think at ClearBridge, in particular, we've seen some -- we have seen some pivoting. And I would continue to expect it. We've seen some real strength in some of their small-cap strategies. And we've also seen some good performance in some of their non-U.S. equity strategies as well. So those are areas where we're going to be a bit focused. And then we're continuing to work on product development with them, extensions of new products potentially around things like MLPs and things like that. They have a fairly good breadth of investment expertise at ClearBridge. And so we're excited about significant -- I think, significant opportunities beyond kind of the core products that we've had a lot of success with recently. As it relates to the multi-asset class thing, look, that is 1 of our -- I would say, 1 of our 3 key areas to grow and build out. We've talked about non-U.S. equity that we want more and broader capabilities in non-U.S. equity or global equity products. We've talked about wanting more products and more capabilities in alternatives. But the third one, the third leg of that stool is really in the multi-asset class space. We do have a division within Legg Mason right now that's called Legg Mason Global Asset Allocation. And GAA, as we refer to it, does do a -- does provide multi-asset class or create multi-asset class solutions from among our existing affiliates. However, we see this as an area that is a real change in the industry, a sustainable and enduring move towards greater customization. And I would expect that we're going to invest more in building out our kind of solutions and multi-asset class capabilities going forward.

Operator

Our final question comes from Eric Berg from RBC.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

I guess, Joe, I hear everything that you're talking about, and it is very impressive, the cost-cutting and the efforts to change the financial arrangements that you have with your affiliates and all the other myriad initiatives that have really been very visible and very noteworthy. So I acknowledge them and congratulate you. On the new -- the one piece that seems to be missing, though, is in the performance area. At least it seems to me, I know you mentioned in passing the 1-year performance numbers. But it appears that the deterioration has been marked and broadly based, at least the appendix would suggest that. What's causing this? Am I reading the numbers incorrectly? And if I am reading the numbers correctly, what are you doing to work on performance that appears to have fallen off sharply?

Joseph A. Sullivan

So, Eric, I think you're looking -- you must be looking really at the 1-year numbers, I think, in particular.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

That's right.

Joseph A. Sullivan

And I think that particularly, if you look at our slide, our strategy AUM is really encompassing everything. It encompasses our mutual fund and retail business, as well as our institutional business. And so at the broadest measure at Legg Mason, if you look at it, our performance actually, in many cases, improved overall at Legg Mason quarter-over-quarter, if you look at the strategy AUM. Now if you look at the long-term, the Lipper numbers, we did take a bit of a step backwards in this quarter. That -- those numbers are heavily weighted by equity mutual funds, and in particular, Royce really -- their relative underperformance, the relative underperformance at Royce, really over the last couple of years, significantly impacted that. In addition, Western Core Plus underperformed by about 7 basis points during the quarter. Much of that has largely reversed in the case of -- just in January, it's up 17 basis points just in January. So that's a big number. The Core Plus number is a big number, and it weights those 1-year numbers. I'm not trying to dismiss it. I mean, we expect better. Our affiliates expect better. But there is a significant weighting of this, I think, by Royce. And that's why Pete mentioned earlier, and I think this is just so important that Royce's numbers, from a relative standpoint -- you've got the Russell 2000 up 37% last year. Great performance by the index. Again, if you look at Royce's absolute performance, it's still pretty staggering. Their top 5 funds in terms of AUM, which would encompass about 75% or so of their total AUM, their top 5 funds are performing very well, the worst of which delivered 28% or 27.5%, 28% last year, the best of which delivered 43.5% last year. So the reality is their performance on an absolute basis is pretty good. They normally underperform in the kind of environment interest rate and other environment that we've had. We're not particularly worried about Royce. I think the other piece is, we had a ding a little bit with a large strategy of ours at ClearBridge, their Energy MLP, which was off about 2.5, 3 basis points for the quarter. That's now back up again. So I don’t want to dismiss it. But there was a little bit of a point-in-time issue there. I'm not overly worried about our investment performance. I feel pretty good about it.

Operator

Thank you. That concludes our question-and-answer session. And I would like to turn the floor back over to Mr. Sullivan for closing comments.

Joseph A. Sullivan

Great. Thank you, John. First of all, I'd like to thank all of you for joining us again this morning. And I want to make a special note just to extend a warm welcome to the Legg Mason family to our new colleague, Tom Hoops. I hope that through the call today, you've been able to see what we see, which is simply continued improvement in the business and financial performance of Legg Mason. As I've said before, while we're certainly proud of our colleagues and we're certainly pleased with our progress, we're also nowhere near satisfied. We can continue to improve, and I believe that we will. We look forward to updating you on our continued progress in building a better Legg Mason. Thank you, and have a good day.

Operator

This concludes today's teleconference. Thank you for your participation. You may now disconnect your lines at this time.

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