Legg Mason's CEO Discusses Q3 2011 Results - Earnings Call Transcript

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Legg Mason (NYSE:LM)

Q3 2011 Earnings Call

January 26, 2011 8:30 am ET

Executives

Peter Nachtwey - Chief Financial Officer

Mark Fetting - Chairman, Chief Executive Officer and President

Alan Magleby - Director of Investor Relations & Communications

Analysts

Craig Siegenthaler - Crédit Suisse AG

Michael Kim - Sandler O'Neill & Partners

William Katz - Citigroup Inc

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc.

Michael Carrier - Deutsche Bank AG

Douglas Sipkin - Ticonderoga Securities LLC

Macrae Sykes - Gabelli & Company, Inc.

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

Alexander Blostein - Goldman Sachs

Daniel Fannon - Jefferies & Company, Inc.

Roger Smith - Macquarie Research

Cynthia Mayer - BofA Merrill Lynch

Roger Freeman - Barclays Capital

Operator

Good morning, and welcome to the Legg Mason Inc. Third Quarter 2011 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Alan Magleby, Head of Investor Relations and Corporate Communications. Please go ahead.

Alan 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 2011 third quarter ended December 31, 2010. 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 in Managements 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, 2010, and in the company's quarterly reports on Form 10-Q.

This morning's call will include remarks from the following speakers: Mr. Mark Fetting, Chairman 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. Mark Fetting. Mark?

Mark Fetting

Thank you, Alan, and I'd like to welcome Pete on his first earnings call. On a snowy day in the Northeast, welcome to all, and thank you for your interest in Legg Mason. Today, we will walk you through our results for our third fiscal quarter of 2011. Legg Mason delivered solid earnings of $0.41 a share, up 46% from last year's quarter on a GAAP basis and $110 million or $0.73 a share on an adjusted income basis. Our results reflect higher total operating revenues flowing from improved advisory fees and strong performance fees, as well as our continuing focus on managing expenses.

As we look at the market results for 2010, we are encouraged by its progress. However, headwinds do still exist, particularly with unemployment, housing and European debt. There is a growing consensus among investment professionals that equities will continue to improve over the coming year. Our managers agree and have a generally positive outlook subject to some cooling off after the recent run up. They believe that residual investor fears are creating some attractive opportunities, particularly further out on the risk curve. As a result, we believe there will be a continued shift into equities, alternatives and specialized fixed income mandates.

In the developed world, they are looking for fragile, yet stabilizing economies to move from recovery to expansion, albeit a soft expansion. This outlook is in line with the most recent comments from Chairman Bernanke. In emerging market economies, they're mindful of inflation and the need for these countries to tighten fiscally. The strength in commodities has continued to aggravate inflation fears. Western believes that in 2011, the economy should broaden and apart from the housing sector, grow at about 3½%, while inflation should remain low in '11 and '12. The team at Western continues to see opportunity in high yield and emerging market debt, even after the strong appreciation of these asset classes in the last year, as well as bank loans, non-agency mortgages and selected opportunities in an oversold municipal sector.

The key question will be when investors will feel comfortable that perceived risks in the market are behind us. Most of our managers believe the real risks are far lower than the perceived risk, and are actively communicating with their clients about the opportunities they see.

But now let's shift to our business highlights on Page 2. Legg Mason reported net income of $62 million on a GAAP basis. This included $24 million in transition-related costs related to our streamlining initiative that we are now implementing and moving well on, as well as $10 million in costs related to our closed-end fund raise. Adjusting for those costs, we had strong earnings, showing the resilience of our core business.

We continued to see improvement in our operating margin as adjusted at 24.3%, which is the best it's been since September of '08. Long-term fund assets, beating their Lipper category averages, improved for the one, three and five-year periods from the prior quarter.

In the quarter, we announced a new executive structure that is fully aligned with our strategic drivers, and we announced that Pete Nachtwey joined the firm as Chief Financial Officer. In October, Legg Mason raised $444 million in the Western Asset High-Yield Defined Opportunity Fund, our second-largest closed-end raised in 2010. With the closing of that fund, Legg Mason became the number one issuer of closed-end funds for the calendar year with a 22% market share.

And we continue to execute on our capital management strategy. In the quarter, we purchased 1.2 million shares. So during the fiscal year, we've reduced our shares outstanding by about 8%. We shift to Slide 3, you'll see our business model. We start with outstanding investment managers. Our managers are responsible for investment performance and on the institutional side, strengthening their product range and servicing their clients. Legg Mason's corporate center seeks to deliver strategic value in three areas: retail distribution; capital allocation, where we raise and allocate capital for organic growth through our affiliates and through acquisitions, and when appropriate, return capital to our shareholders. And finally, through our governance group, we ensure that the firm carries on its business in accordance with the highest standards.

The combination of our affiliates and the strategic services provided by Legg Mason are the key elements to delivering value to our clients and therefore, to our shareholders. Slide 4 discusses changes to our executive committee. In December, I announced the realignment of our teams so that each member has clear focus on a key element of our growth strategy. Joe Sullivan is responsible for global distribution.

As we looked at our business, it became clear that it made sense to have one distribution effort that taps into the best practices of both our Americas and International platform. Joe will be responsible for growing our market presence across the globe. He will continue to be responsible for completing the execution of our streamlining process, where his strong team is making great progress. Ron Dewhurst is Head of Global Investment Managers, and is responsible for working with our affiliates to grow their franchises. Jeff Nattans is Head of M&A and Business Development, and will be charged with growing Legg Mason's franchise through strategic and bolt-on acquisitions. Pete Nachtwey has joined us as Chief Financial Officer, and will expand the role to oversee many of our critical administrative functions. You'll hear more from Pete a bit later. And finally, we added Tom Lemke, our General Counsel to our executive committee in recognition of the importance of the governance functions.

Slide 5 shows our assets under management at $672 billion in line with the prior quarter. As you can see, equity assets are now at 27%; fixed income, 53%; and liquidity, 20%. Importantly, equity assets as a percentage of total AUM were the highest they've been since the June '08 quarter. And when you cut the pie by revenues for the quarter, equities generated 43%; fixed income, 33%; alternatives, 16%; and liquidity, 8%. Strategically, we will seek balance across these revenue streams, going forward, with an added emphasis on Global Equities and alternatives. Higher equity assets have had a positive effect on our advisory fee yield, which is now 35 basis points versus 32 a year ago.

Slide 6 shows our net flows by asset class. Fixed income outflows were almost $13 billion for the quarter, and virtually all of that was driven by [indiscernible]. We will provide more color around Western flows later in the presentation, but I wanted to highlight the key drivers of these outflows. The two legacy clients we discussed last quarter, the lower yielding sovereign mandate and the separate account that was ending this quarter, accounted for $4.1 billion of the outflow. There was a liquidity-like low-fee mandate with $2 billion of outflows, that client remains with Western. Reflecting industry trends, Western had municipal outflows of about $500 million compared with inflows of $900 million last quarter. There was also a pick-up in outflows related to lost accounts, which reflects some seasonal rebalancing, manager diversification and a continued move by some institutions to a bifurcation of risk. To explain bifurcation of risks further, some clients, the largest plans, are retaining more of the asset allocation decisions and rotating into sector-specific, specialized in long duration strategies.

As a result of this trend, searches for Core and Core Plus mandates are down since '08, even while the category remains the largest overall and a fertile field for Western. So for us, this slows the rate of turnaround in Core, while picking up opportunities in specialized mandates. I'll walk you through this in more detail as we did last quarter in a later slide. Equity outflows were approximately $3.3 billion for the quarter, reflecting a modest improvement. Permal, Royce and Brandywine had net inflows in equity.

Slide 7 shows our assets by affiliate in order of their contribution to earnings. First is Western at about $454 billion. As noted earlier, we will review Western's flow picture in more detail later on. On the investment front, Western continues to add talent to their team, particularly in product areas where they see growth. This past quarter, they've added a senior portfolio manager with a strong global, multi-sector background. They also added a senior product specialist with a deep background in absolute return strategies. And their new advisory services initiative is paying and yielding early returns.

Second is Permal at approximately $20 billion, up 6%, reflecting net inflows for the quarter of $500 million, as well as market appreciation. They've seen good subscriptions into their flagship funds from Europe and Middle East, and their separately managed accounts with underlying hedge funds have passed the $5 billion mark. Institutional accounts have grown to nearly 40% of their business. Their institutional pipeline is strong, with $300 million expected to fund in our fourth fiscal quarter already, and they are in the running for several other public sector mandates. In the High Network segment, they've seen flows in interest from regional private banks.

ClearBridge ended the quarter at $56 billion. The key to growth for ClearBridge will be the retail investor becoming comfortable with equities in a big way. They are beginning to see flows from new RIA platforms, as well as a reallocation back to equities from existing clients. In the meantime, ClearBridge has continued to build out its institutional presence. In the quarter, they won $170 million from an existing financial services client, as well as several smaller mandates from institutions.

Fourth is Royce, ending the quarter at $40 billion driven by inflows and market appreciation. Royce continues to do very well throughout its business. They launched four new funds on December 31, and they began marketing them this month. Legg Mason Capital Management ended the quarter at approximately $16 billion. Performance continues to be challenged for certain time periods, but in the past two years of the recovery, essentially from the trough, four of the six funds managed by LMCM ranked in the top quartile of their Morningstar peer group, and the fifth is in the second quartile. For example, at close to this market trough, an offshore version of the opportunity trust was launched in February of '09 and has raised more than $125 million to date in Europe. Their newest funded diversified research fund was launched in July of '10, is off to a good performance start and is a stock picking fund designed to have lower tracking area. I do note, as you can see in the mutual fund data, they've started very strong in 2011.

Batterymarch ended the quarter up 6% at about $23 billion, driven by market appreciation. Six of eight of their institutional composites had strong years in 2010. They continue to see positive flows in their emerging market products. However, in the quarter, this was somewhat offset by one large existing client reallocating. Legg Mason's international distribution team recently worked with Batterymarch to see the global absolute return product in response to client interest. Brandywine ended the quarter at $32 billion, saw modest inflows in both equity and fixed income.

Fixed income performance continues to be strong. They are seeing some of the same trends in the fixed income business as Western in terms of larger pensions moving into LDI, passive and specialized mandates. Legg Mason has been working with them to expand their product offering. A year ago, we work together to bring a high yield team onboard. They now have a one-year track record, and Brandywine is in the beginning stages of marketing this product.

Slide 8 shows long-term performance of our funds. As you can see, the three-, five- and 10-year performance continues to be very strong.

Slide 9 shows an update on Western's business mix. The pie chart at the top breaks out Western's assets under management by broad asset class. You can see the major product strategies, including broad market, which includes U.S. and non-U.S. Core and Core Plus assets; taxable liquidity; municipals, which includes both short- and long-term and a number of strategies that fall into this category of specialized assets, which is an area of opportunity, as I discussed earlier. Western has investment teams on the ground in all of the major markets, which allows them to offer clients any fixed income solution in virtually any currency base. And with strong performance in Core and Core Plus, we expect to continue to compete even better there as well.

This brings us to a discussion of flows, both from where we continue to see some headwinds, as well as where we see incremental growth and are seeing incremental growth. Approximately $5.3 billion of this quarter's outflows came from two large offshore clients in lower fee mandates. This includes $3.4 billion from the global sovereign account we referenced last quarter, where the bottom line impact is de minimis. And roughly $2 billion comes from a liquidity-like mandate where the fee is less than 10 basis points. That client remains an important client of Western's with inflows into other products.

We also saw a pick-up in muni outflows consistent with the industry. Western had outflows of approximately $500 million for this quarter, compared with inflows of about $900 billion for a swing of about $1.4 billion from the last quarter. Now current conditions for inflows remain a headwind, though we do note they abated somewhat in the latter part of this month. Current conditions in terms of investment opportunities, on the other hand, our investment team sees real value in these oversold areas. And as we mentioned last quarter, expected outflows from a sub-advisory mandate terminated this quarter with approximately $700 million out, slightly less than expected. That client remains a client of Legg Mason, and we expect inflows into other Western managed strategies this year. Portion of the rest comes from an uptick in lost accounts of about $2 billion, which reflects seasonal year-end allocation decisions. Those were communicated in the quarter, particularly in December. Overall, closed accounts are down 50% from a year ago.

Now let's talk in more detail about the positives. Western is realizing benefits from the move to specialized. Importantly, assets being won are often higher fee assets, partly offsetting lower-fee business that they are losing. Won, but not funded in the quarter, was $4 billion, up from last quarter. And Western doubled the number of assets in finals presentations compared with the prior quarter, with presentations for nearly $6 billion in assets in the December quarter alone. Nearly 90% of the $4 billion won but not funded pipeline in the quarter is in what we would term specialized mandates. Asset classes in which they are seeing gains include local currency, global credit, global multi-sector and inflation link.

Globally, in the mutual funds managed by Western across the board, we continued to see inflows in the quarter. And in fact, we started this month with Core Plus by getting some nice inflow based on its performance record, the Western Asset Core Plus fund. As Western continues to focus on offense, the pipeline and the number of finals presentations are growing. We are determined to deliver more competitive growth rates, though the exact timing continues to be hard to predict. Slide 10 shows our flows in the Americas distribution area.

Net outflows increased by about $500 million. This is primarily attributed to a swing of $1.4 billion in the previously discussed municipal funds area. As we mentioned last quarter, we had four individual or sub-advisory accounts across several of our managers terminating, and that concluded in the quarter as expected. We have begun to build a pipeline of won but not funded mandates for calendar year '11, stretched out over several quarters of the year.

And finally, we continue our leadership position in closed-end funds. For the year, Legg Mason was the leader in raising new funds by assets, and plans are underway for new innovative offerings in '11. Turning to International on Slide 10. We posted our eighth straight quarter of positive net flows, driven primarily by Japan and Europe. Fiscal year-to-date, there's been nearly $7 billion in net inflows. Interest continues to be driven by fixed income products, particularly local currency and global bond products. On the equity side, Royce, and to a lesser extent, ClearBridge, were both positive contributors. Net flows, though positive, did decline during the quarter reflecting some seasonality in sales in the month of December, as well as some one-time redemptions from certain clients that are not indicative of an overall trend.

Slide 12 highlights the success we've had working with our affiliates in new product launches. As you can see, they cut across a number of affiliates in different regions around the world. They total over $11 billion in assets, further proof that innovation can contribute to strong growth. And now I'd like to turn it over to Pete for a review of our financials.

Peter Nachtwey

Thank you, Mark. Before I get started, we thought it might be helpful to tell you a little bit about my background. Prior to joining Legg Mason, I spent almost four years as CFO of The Carlyle Group, also serving on their operating committee, which was responsible for running the firm on a day-to-day basis. As a CFO there, I had responsibility for all financial and most support functions, as well as serving as global COO for their growth capital and real estate fund groups, experiences which will be helpful background for the expanded CFO role that I'll play here at Legg Mason. Prior to Carlyle, I spent 27 years in various leadership positions at Deloitte. So suffice it to say, I'm very excited to be joining Legg Mason and Mark's team at such a key time in its history. And I look forward to meeting and working with each of you in the months and years ahead.

So jumping into the financials. If you turn to Slide 13, I'll cover the highlights for what was actually a strong quarter financially, but might appear so at first watch. As Mark noted, we reported GAAP net income of $62 million or $0.41 per diluted share. But these results were negatively impacted by costs incurred in the quarter related to the streamlining process and a closed-end fund launch. Taken together, these reduced our diluted earnings per share by $0.14. One significant positive this quarter was the improvement in operating revenues. At $722 million, these were up 7% from the September quarter. The contributors to this strong result were as follows: average AUM of $672 billion was up 2% from the prior quarter, but the real key here was the mix of assets, as Mark has been pointing out.

The increase in our average AUM came entirely from the higher-yielding equity assets that we were able to either accumulate or due to market performance during the course of the quarter. With this increase in equity assets, as a percentage of total AUM, they now stand at 27%, up from 25% at the beginning of the year. Accordingly, we have seen an increase in our advisory fee yield this quarter to 34.8 basis points from 33.8 sequentially, and 32 basis points year-over-year. Permal and Royce were the primary drivers for this improvement.

And lastly on the revenue front, performance fees increased by $15 million from the September 2010 quarter to $35 million. This is our highest level of performance fees in three years or since the December 2007 quarter. Continued strong investment performance has led to contributions from many of our affiliates, led by Permal with approximately $20 million in performance fees and Western with roughly $10 million in performance fees. Approximately 60% of this period's performance fees were quarterly fees, with the remainder representing accounts where we earn and bill fees on an annual basis.

So now switching to expenses. Our operating expenses of $625 million increased 6% from the prior quarter due to a closed-end fund launch and the increase in transition-related costs. I'll go into more detail on the expenses a little later. The adjusted income for the quarter was $110 million or $0.73 per diluted share. Operating margin as adjusted was 24.3%. This continues the trend of improving margins, and is our best adjusted operating margin since the September 2008 quarter.

And finally, our average fully diluted share count stands at 151 million shares as of 12/31, reflecting additional repurchases during the quarter of 1.2 million shares. So over the last three quarters, we have repurchased 12.6 million shares, resulting in our share count being down 8% from the end of fiscal 2010. Of the $1 billion authorized by the board, we have $624 million remaining and we anticipate, subject to marketing and company performance, repurchasing an additional $40 million of shares by the end of fiscal 2011.

Now turning to Slide 14. You will note here, as we covered in the highlights, that Legg Mason's financial performance continues to show signs of steady improvement in our core operating business, both sequentially and year-over-year. Also recall the last quarter's results included the $9 million U.K. tax benefit. So while we're on taxes, let me address the nearly 39% tax rate that appears in our GAAP financials this quarter. This is higher than normal as a result of FAS 167, which came into effect this fiscal year and requires us to consolidate certain funds that we manage. Thus in our financials, we recorded $8.3 million in pretax expense associated with the increase in fair value of the debt related to consolidated investment vehicles. But there's also an offsetting amount flowing through the net loss attributable to non-controlling interest, resulting in no bottom line impact on net income. But it does distort the effective GAAP tax rate. For guidance purposes, our effective tax rate remains in the approximately 35% to 36% range.

Turning to Slide 15. As I previously noted, our operating expenses of $625 million increased 6% from the prior quarter. The drivers behind this $38 million increase were threefold. Transition-related costs of $24 million were $12 million higher than the prior quarter, reflecting the management realignment that Mark discussed earlier, and which we announced last month, as well as a real estate-related write-off for our operations in technology shared services center. In addition, we had approximately $10 million in cost that flowed principally through the distribution and servicing expense line. This related to the Western high yield closed-end fund launch, where we raised $444 million in new money with an annual advisory fee rate of 80 bps. And finally, due to higher net revenues, our comp and benefit expenses increased by approximately $13 million.

So if you flip to Slide 16, we'll get a little more into comp and benefits. When you exclude the transition-related costs of $20 million and the mark-to-market unfunded deferred comp and seed investments, the comp and benefit, the net revenue ratio comes in at 52%. This includes the impact of the closed-end fund costs on both the salary and incentive line, as we talked about earlier. Just so the 52% substantively is right in the 52% to 53% target range that we previously communicated.

As both Mark and I pointed out on Slide 17, our operating margin as adjusted at 24.3% is the highest result in over two years. This, despite the impact of the closed-end fund launch of 1½% in this quarter. Also, this result only nominally reflects the benefit of our streamlining efforts, which are expected to ultimately add 600 to 800 basis points to our operating margin when completed at the end of fiscal 2012.

Turning to Slide 18. We are now six months into our streamlining initiative, and the first phase of targeted cost reductions were completed as of December 31. We continue to make solid progress on the transition of services to our affiliates, as well as the other cooperate cost reductions. As a reminder, we are targeting $130 million to $150 million in combined savings, and we expect to incur about $130 million in transition-related costs. To date, we've incurred almost $39 million of those costs and have generated initial run rate savings of $12 million. We anticipate incurring approximately $15 million in streamlining-related costs in the current fiscal quarter, which will bring full year transition-related expenses to approximately $54 million.

As you can see on Slide 19, the estimated impact on our GAAP financial results in fiscal 2011 is a negative $35 million, which reflects the $54 million in transition-related costs net of savings that we are anticipating from actions taken this year. In fiscal 2012, we expect a positive net GAAP impact of approximately $15 million, as some of the transition-related costs originally expected next year will have been recognized in fiscal 2011. The $15 million net benefit includes the impact of additional transition-related cost of approximately $80 million, which will be more than offset by the expense savings in fiscal 2012. And ultimately, we expect to achieve our $130 million, $150 million in run rate savings by fiscal Q4 2012.

So with that, thanks for listening. I'll turn it over to Mark for his closing comments, but I also want to let you know that I look forward to working with the investment community as we go forward, and meeting each of you personally in the very near future. Mark?

Mark Fetting

Thanks, Pete. And I want to close with a discussion about our strategy for 2011 and beyond. There are three key strategic drivers. First and foremost, we want to differentiate ourselves as having outstanding, independent investment managers. Our managers have been focused on improving and maintaining investment performance. We've got strong performance at many of our affiliates, and the others are working hard to complete the task. Second, a Corporate Center that delivers strategic value. During calendar year '10, we sharpened our focus on these activities. And we are very, very clear about value creation and distribution, capital allocation and even governance doing the right thing, no chalk, as we say here at Legg Mason. I think the streamlining progress that is apparent, as we now get closer to the full transition of services over the next fiscal year, underscores what we can do in rightsizing our Corporate Center and focused on strategic value. Thirdly, diversity and balance. As we expand our business, we seek strategic balance across products and asset classes, geographies and channels. Our management team and our affiliates are all focused on playing offense. We see significant opportunities for the firm in 2011. Finally, I want to thank Terrence Murphy, who did a tremendous job as interim CFO, and I know that the teams at ClearBridge are thrilled to have him back full time. So now we'll open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Dan Fannon at Jefferies.

Daniel Fannon - Jefferies & Company, Inc.

Looking back at Page 9 here that you gave us. You comment about seasonality. That appears to be a backward-looking comment for the December quarter. And I just want to clarify that or do you expect that to continue? And then on the theme of rebalancing, you guys have talked in the past about seeing increased RFP activity, as investors look to diversify away from some of the other kind of larger players that have benefit over the last couple of years from inflows, from the likes of Pimco. Is that something that is occurring? In terms of rebalancing, maybe you're actually benefiting a little bit of that from some of the other players out there?

Mark Fetting

Yes, Dan. The first question was on, what was it? Give me that first question again?

Daniel Fannon - Jefferies & Company, Inc.

Basically, the talking about the seasonality comment. That appears to be something that was a December event and backward looking, or is that something you expect to continue going into the March period?

Mark Fetting

I think there's always some decisions taken at year end that kind of are funded in and out in that first quarter, but I don't expect it to be anything more than what we saw in the December quarter. I would say, in terms of the diversification issue, that's a key development. And we are definitely benefiting from that in a number of cases where they're seeking just more managers and particularly in the specialized areas, becoming aware of Western's very strong capability in that. And then on the -- I'd say kind of historically, and we see this more legacy, than go-forward, clearly, Western was one of just a few being used in that Core, Core Plus area. We think most of that on the negative side is behind us, but there's still some element going forward. The good news is Western has reestablished itself as a real leader in fixed income, as viewed by the consultants and the clients. And we're hoping to show kind of better results on the growth front as we go forward.

Daniel Fannon - Jefferies & Company, Inc.

And then I guess just to get a sense of, I know timing is difficult to predict. But I mean, in terms of the momentum you're talking about on the sales front that appears to be accelerating, you are having some new issues apparent with the muni side coming up. But would you characterize how that transition period of turning towards positive flows? You're in a better spot today than you were three months ago? Or has it kind of stagnated and gotten worse? Just trying to get a sense of kind of how you feel or how close you think you are to that transition.

Mark Fetting

The momentum inside Western continues to grow across all mandates in terms of opportunities and retention successes. The one thing I was trying to point out is to give you all an update on the marketplace. And the marketplace, you clearly do see this shift towards kind of a bifurcation at the largest plant sponsors. And in that regard, candidly, some of the Core, Core Plus mandates moving into specialized has taken some, I think, rate of acceleration of the turnaround at Western has pushed it out a little bit. We're still going to deliver it, it's just going to push it out a little bit. On the other hand, it gives us an opportunity on the specialized. Now, beyond the largest plans, there's still a strong appetite in the mid to smaller size and I think things like our Western institutional fund should be the beneficiary of that. And then in the retail side, a core strategy remains probably the most popular. So we see momentum continuing to be quite strong, Dan.

Operator

The next question comes from Roger Freeman at Barclay's Trust Capital.

Roger Freeman - Barclays Capital

I guess just on Western, just looking at the performances for the top funds. Just again, Lipper numbers. It looks like there’s been some relative deterioration over those sort of three months and then one month, three months, six months period. And like in munis, for example, too. I think where you say you see opportunities there. I mean, is it just a function of sort of positioning relative to market performance, particularly in munis as yields of spreads have remained wide or wide and faster than probably they expected?

Mark Fetting

Roger, actually on the Core, Core Plus funds of Western, the performance continues to be stronger in kind of affirming a top quartile kind of record on a one, three- and five-year basis. And in fact, I think that's being rewarded in the marketplace. And I noted, which you guys can see through your own data, just in January alone, we're getting some positive inflows in one of those flagship funds. On the municipal side, our long-term record under Joe Dean and his team has been excellent. And he candidly, I was just talking to them, talked about in light of the dislocation going on, kind of accepted some short-term in the one year number performance fallback out of confidence of what can be done when you get through this period. And that's proven well over his long-term record. So we feel quite good about the performance across the board at Western, Core, Core Plus and in particular, muni, and even areas where there is still some work to be done, I think they're doing it well.

Roger Freeman - Barclays Capital

And then just on flows. One is the sovereign client, I think you talked about that being like $1 billion a month kind of rate and looked like that's what it was for the quarter. I mean, is that reasonable to assume that, that probably continues for some period of time?

Mark Fetting

It is our current understanding that, that would continue. I do kind of restate that the impact, because of the size of the account, is de minimis on the bottom line. So while it's not a good thing to be losing those assets, we are offsetting it in other situations at higher fees. So the net is a plus.

Operator

Our next question comes from Bill Katz at Citigroup.

William Katz - Citigroup Inc

My first question, I know you've just kind of helped us to mention just the trade off here. Can you size at the end of the year where the Core, Core Plus is in terms of asset management? If you said it, I apologize. And then relative to that, what the fee rate differential is, maybe broad brush strokes between those products? And some of these more specialized products that are coming on?

Mark Fetting

Yes, Bill. Actually, if you go to the new chart that we did, you'll see that I think it's about 23% is in the broad portfolio, which is largely U.S. and non-U.S. Core and Core Plus. So you can just work the math, 23% of $454 billion in total. Here again, what we're saying on that is that is the largest category in both the institutional and retail space. But in the largest end, the institution is moving towards this bifurcation of risk. What you would expect in terms of Western's recovery and winning business is kind of slowing a little bit versus prior cycle expectations, and we're just kind of alerting you to that. At the same time, the specialized is a real opportunity and they're taking advantage of it. I would say the specialized tend to have roughly about a 50% higher fee range on a gross fee basis and it obviously, as you know, varies by size. So it's difficult to give absolute numbers.

William Katz - Citigroup Inc

My second question is for Peter, and congratulations. If you look beyond the $40 million, you sort of highlighted through the end of this year, you're still sitting on a significant amount of liquidity. Could you talk a little bit about your thoughts between buyback versus acquisition? And how you're sort of thinking about the relative deployment, particularly given your track record at Carlyle?

Peter Nachtwey

But in terms of the $40 million share buyback, again, it's difficult to predict exactly how we'll deploy the rest. It depends on both our performance and the performance of the stock. But we do tend to deploy the majority of the rest of that over time. And keep in mind, we're generating a reasonably significant amount of cash every quarter, every year. On the acquisition front, Jeff Nattans, Mark and I are just really starting to set sit down. This is day 11 for me, I think, at Legg Mason. So a little premature to get into any detail in terms of acquisition strategy. But we're definitely interested in finding ways to grow the platform.

Operator

The next question comes from Michael Kim at Sandler O'Neill.

Michael Kim - Sandler O'Neill & Partners

First, maybe just a follow-up on kind of the outlook for the fixed income business. Are you starting to see pension plans and endowments maybe getting a bit more proactive in terms of replacement activity? And how might that potentially change your thinking in terms of kind of the flow trajectory for Western?

Mark Fetting

Michael, unfortunately, we did not share in a lot of the surge into fixed income, particularly on the retail and kind of quasi-retail side. So while we do see clients shifting from fixed to equity or alternatives, we think relative to our Fixed Income business, where we are in our cycle of kind of recovering with good performance, the kind of year-over-year comparisons are likely to be positive. It's certainly been the case thus far in terms of just momentum. Having said that, I would've liked to have captured more of the opportunities that did take place in the last couple years.

Michael Kim - Sandler O'Neill & Partners

And then maybe just turning to the equity side. Assuming retail investors do increasingly rotate back in favor of equities, how much of a concern is it for you that maybe some of your one-year track records, particularly at ClearBridge, might be somewhat of a headwind for flows in that type of scenario?

Mark Fetting

Actually, you got to go manager by manager in that kind of one-year situation. One of the kind of asset clusters that's got less of a one-year strong number than we usually have is in Royce. But Royce is always in years of kind of high gross returns, Russell 2000, up 20%, et cetera. Royce is always not fared as well. But over the long term, they've delivered, which is why they are the leader in the business that they are. So they're not concerned. Chuck, Whitney and the team, they're not concerned about that not seeing an impact of that in their business. I would say the same is true in ClearBridge. If you take appreciation as an example in the kind of most recent market run up, that kind of more conservative strategy should give back some of the good performance relatively that they've achieved through the more challenging times. So I think, net-net, we're going to fare fine. I think we have to tell the story of each and every of the situations against the clients that we serve.

Operator

[Operator Instructions]. Our next question comes from Cynthia Mayer, Bank of America.

Cynthia Mayer - BofA Merrill Lynch

I guess in terms of the restructuring, can you give a little more color on the pace of incremental savings you expect? I think you mentioned there were only nominal cost savings this quarter, but that you've achieved $12 million in run rate savings. So I'm wondering, does that mean $12 million in -- does that mean extra savings this current quarter? And can you talk a little bit about pace of savings after that?

Mark Fetting

Yes. Let me kind of profile this, and then I'll turn it to Pete with some more color because I think this is an important issue because I want everyone to know that we are now entering the phase where these savings are being realized. They will be offset by the transition costs. And so the net is why we're being kind of conservative in terms of guidance going forward. But I do think it's important that you recognize that there will be transition-related costs in the P&L that rightfully will not be recurring once we complete this process and achieve our goal of $130 million to $150 million. Pete, any further?

Peter Nachtwey

Yes. And it's a little difficult to give you the exact numbers by quarter because we're still in the process, as we work through with each of our affiliates and with a very shared cost centers exactly when we're going to do cut overs. I think over the period between from now and fiscal 2012, if you kind of radically take where we are today, we're at $12 million on the run rate. We expect to be at an average of $140 million, and just take that almost on a straight-line basis. In terms of how the pick up would work, this is probably as close as we could get you. That make sense?

Mark Fetting

Cynthia, we want to make sure you're all right on that.

Cynthia Mayer - BofA Merrill Lynch

Yes.

Operator

The next question comes from Robert Lee at KBW.

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

I actually have a kind of a broader question, kind of the strategic question on the management realignment. I guess there's maybe a couple of pieces to this move. Could you talk a little bit about what drove you to make some of the changes in your former head of distribution in the U.S., had only been there a couple of years and obviously, had this CFOs role to fill. Was part of this, not just the overall streamlining, but maybe more quite happy of the pace of improvement in maybe the retail part of the business? And maybe talk a little bit about with Peter's role here, how the CFO's responsibilities or his responsibilities may be expanding versus what they used to be?

Mark Fetting

It really is driven by my sense of the importance of growth going forward for the company and what will drive that growth. And it's across these three strategic priorities. Making sure we have best-in-class managers and therefore, asking Ron Dewhurst to focus exclusively on managers and not kind of covering some managers and doing some distribution exclusively on managers and working closely with me and the affiliates on how we can kind of optimize their businesses going forward. The second is the importance of a corporate center that drives value, and the first area is distribution. And ask Joe Sullivan, who's got a good, long record building businesses in intermediary channels that focus exclusively on distribution, and to do it globally, so that we can really kind of align the best of both around what we're doing in Americas with what we're doing in International. To ask Pete Nachtwey to join us and in attracting Pete, and we had quite a lot of very high caliber applicants for the position. But it was clear to me that Pete could bring not only strong CFO skills coming to us from Carlyle and before that, almost several decades at Deloitte in their financial services area, but also had a skill set around overseeing administrative functions and thinking strategically about things. Tom Lemke, on the government side. I think in our business going forward, we need to continue to lead of doing things the right way on a no chalk basis across the board. And then, finally, on the M&A with Jeff Nattans, who've been with us now for about four, five years but previously had a career at Goldman, in fact, worked with us on acquisitions at Goldman. I think the idea is I believe we can and will do better. It's not critical of what we've done in the past, but the recognition that we can do better and my decision to align the team accordingly.

Operator

The next question comes from Jeff Hopson at Stifel, Nicolaus.

J. Jeffrey Hopson - Stifel, Nicolaus & Co., Inc.

So Mark, I get that within fixed income moving towards specialized areas, but do you see any signs from institutional clients if we get into an higher interest rate environment, what they're going to do between various asset classes? Obviously, retail has moved a little bit away from fixed income in the shorter term. But any sense of what the institutions broadly, how they'll react in a higher interest rate environment toward the total category of fixed income?

Mark Fetting

Yes, I think in a rising rate environment, which clearly we're seeing the beginnings of, albeit at a kind of a smaller stage now but over time, you'd have to assume it would build. That we believe fixed income remains a key asset class for diversified portfolios. We think a good bit of the so-called “hot money,” I think, came more in the retail side than the institutional sides. So the rebalancing there, as I said, unfortunately, we're not going to be as exposed to that because we didn't share in it as much. And then I think overlaid into that is this shift at the largest clients and probably gets extended into the institutionalization of the big broker-dealers, where they have various gifted investment professionals doing kind of sophisticated stuff on their model portfolios, seeking kind of a better balance between a core piece and a specialized piece. And I think, as a result, fixed income will remain an important area, and hence, we see good opportunities at Western and specialized areas at Brandywine. But at the same time, it will be helpful to us to get some more flow into the equity and alternative side, where we have good capability there too.

Operator

Next question comes from Mike Carrier at Deutsche Bank.

Michael Carrier - Deutsche Bank AG

Mark, just when I think about the Institutional business, I just want to get your thoughts on how the overall franchise is positioned. Because if I think about if you look at a lot at the consultant studies that are out there and what the institutions are saying, you can get a range from 1% to 3% of a possible allocation out of fixed income. Now like you guys pointed out, you can gain in certain products and lose in others. But just that trend, if it's going in favor of equities and then some alternatives, you have some of those products, but a lot of your equity products are weighted towards retail. So just do you have enough of those products in the overall Legg Mason franchise to benefit from that trend? And then if not, would that be an area that you'd have interest in acquisitions? And then one thing on the pipeline, you just mentioned $4 billion of funds that have been won or mandates that have been won. I just wanted to see if you had any type of like a net number for the outlook.

Mark Fetting

Yes. Michael, on the latter one, we don't have the net number, but all I can repeat is that the momentum continues to be very favorable of opportunities to win and win rates. So as long as that continues to happen and the continued decline in the closed accounts and that kind of stuff, that would look good. But because of a couple of these moving pieces like munis, et cetera, I'm going to refrain from a net number. On the equities fund, I think first and foremost, we have some very good capabilities in the equity side on the institutional, Batterymarch is an example. Six of eight of their composites having good, strong calendar year '10 numbers bodes well for them as a quantitative, largely institutional manager. Even Royce got some initiatives underway at looking at kind of selected Institutional business that previously they were not willing to consider. I would say, having said that, the importance of bolstering our equity capability down the road in the international equity area would be quite important and remains a priority. Finally, on the alternative side, Permal has really delivered throughout this time period in a space that was hit hardest as a category, consistently strong investment performance, relative to peers and consistently strong partnering with the quality business in institutions and distribution partners, and they keep coming back. And when the combination of not only this institutional piece, which is happening, kicks in even more but that high net worth investor comes back into kind of offshore fund of hedge funds, I think it's going to be very compelling.

Operator

The next question comes from Craig Siegenthaler at Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG

Just had a follow up to Cynthia's on the income statement. If I look at the $12 million run rate that you said is embedded kind of in the 24.3% operating margin, that means there's only about $23 million left of additional kind of expense saves. If you add those two together, you'd get around 27% to 28%, so kind of below your 30% margin goal given kind of steady state revenues. So I'm just wondering what I'm missing there. I could run through the numbers again if you'd like.

Peter Nachtwey

Yes. Why don't you, Craig?

Craig Siegenthaler - Crédit Suisse AG

Right now you said there's $12 million of run rate expense saves in the current number, which is a 24.3% operating margin. If I take that $12 million of run rate savings out of the guidance, which is $35 million on average, you get a $23 million number. That $23 million, if I just divide it by 700, assuming revenue's flat, that only gives me about 3% to 4% of additional margin upside on the 24.3%. On that math, I missed the margin goal of 30.0%.

Mark Fetting

Alan, why don't you jump in? It seems. . .

Alan Magleby

In terms of total savings that we anticipate at the end of Q4 2012, we're still feeling very good about the $140 million, which we'll get. Is your questions, Craig, just around the current quarter or where we're going to end up when we're done?

Craig Siegenthaler - Crédit Suisse AG

If I take out the $12 million, there's a $23 million difference. That's how much expense saves you should have left because you already did $12 million and you expected about $35 million. So If I just take that $23 million divided by your current revenues, I only get another 3% of extra margin savings left. Because you're at 24.3%. That only gets me about 27% and change. I was wondering how do I get to the 30% margin target.

Alan Magleby

Craig, that $12 million number is a go-forward number. It's not really baked in these current numbers.

Craig Siegenthaler - Crédit Suisse AG

So as I think of next quarter, that's kind of a starting point, the $12 million, but it wasn't really fully embedded in this current quarter?

Alan Magleby

That's correct. We're still solidly on track, as Pete suggested, for the total of $140 million. I think just sort of, if you need a little bit more color on what was baked into this quarter, it would be about $4 million. But the $12 million is what we've nailed on a go-forward basis.

Operator

The next question comes from Roger Smith at Macquarie.

Roger Smith - Macquarie Research

I want to get an idea really of what's going on in the alternative space. And when Permal is seeing activity here, can you guys tell where that's coming from on the fixed income side? Meaning, is it coming sort of out of taxable liquidity or is it coming out of core or specialized? And I'm not specifically talking about you guys because I'm assuming it's coming from all different places. So I guess what I'm trying to understand, is it really the hot money that's coming out of fixed income and going into alternatives? Where was that per se? And then when it comes into the alternative space, is there something, a specific product or some kind of investment process that they want? Meaning, is it a specific fund or is it a fund-to-funds, our how's Permal sort of addressing those needs?

Mark Fetting

Roger, let me be clear. I kind of referenced the hot money more on the retail side than the institutional side. If you just looked at the substantial gross inflows into mutual funds in both '09 and '10, it's in aggregate of almost a record number and it's because of the unusual concentration in fixed income, and that, I don't think sustains itself. And I think in prior periods of kind of rate reversals, it's proven to be kind of an area where you'd see some redemptions. On the institutional side, I do think that the margin clients are allocating away, but not as dramatically as I would expect could happen in retail. In that regard, where Permal is seeing the benefit, it's principally in the public fund side of the Institutional business. Not as much, although, some in the large corporate and also globally. Permal is done a terrific job in building up their Asian business and in China in particular. They have won mandates from virtually all of the largest sovereign investors there, and they have launched China-specific funds and strategies that are taking advantage of those local economies. So I would say one of the things that Permal, in particular, has done well has kind of created an engineering capability around customized solutions for clients in the institutional space that really respond to their need for diversification.

Operator

The next question comes from Mac Sykes at Gabelli.

Macrae Sykes - Gabelli & Company, Inc.

In terms of the M&A market, how is the change do you think in your view over the last year? Do you expect a pick up in transactions going forward? And then, I guess, do you see some particular value in any specific asset class right now?

Mark Fetting

Well, I think first off, just generally, there's clearly, I think, more activity and interest. We're particularly interested in properties that are not kind of shopped. But conversations are kind of resuming from, I think, talent investors who kind of saw in the downtick of the crisis an unappealing time to kind of discuss a potential strategic transaction. I think those are now kind of at least resuming. I think it's still some time to see kind of whether or not anything happens. And for us, here again, it would be more of a targeted addition to our mix as opposed to anything big. And so I think it's kind of game on in terms of good properties and what we see as an opportunity to really be seen as the place to go for someone who wants to continue to focus on investing and let us help on the other stuff.

Operator

The next question comes from Doug Sipkin at Ticonderoga.

Douglas Sipkin - Ticonderoga Securities LLC

I just had a question on the closed-end fund. Just trying to understand the economics behind it and maybe my math is wrong, but I sort of take what you raised, take the management fee and take what you paid. Assuming a 100% margin on that management fee, it would still take less than three years to break even. And then I'm sort of practically thinking probably a 50% margin because I know they're pretty high-end, closed-end funds. It would take under six years to break even. So I'm just trying to think of the practical business rationale behind raising $440 million, I think, at 2.3%. I'm probably missing something, but it just feels like the breakeven is very long.

Mark Fetting

Yes. Actually, our analysis, when you kind of put all the numbers together which is probably difficult for you to do, Doug, is more of the breakeven is the latter end. I mean, it was in the front end of that. So we see it against an acquisition that we look like. If you tell me an acquisition where you get like kind of three- or four-year break even, that's a very attractive deployment of capital. We see that's the same in the closed-end business. So the kind of financial returns are very strong, well under your outer range. The strategic benefit of deploying kind of an existing resource into a companion product, if you will, has attractive margin to our managers. And to be a leader in an important area where we go in and as you know, we've talked about the importance of diversifying our distribution mix. Well, we're getting in corner offices of partners that we don't have as good a recognition and we're dealing with their top producers in a way that they really are between the MLP that we did on the equity side earlier with ClearBridge and more recently, with this Western piece, it bodes very well. So we like the business a lot for all of those reasons.

Peter Nachtwey

Doug, this is Pete. Just to add on to that, keep in mind there is very little additional cost that we have on a go-forward basis for these things. It's all up front. So this is pretty much dropping to the bottom line as we earn it on a go-forward basis.

Operator

Your next question comes from Alex Blostein at Goldman Sachs.

Alexander Blostein - Goldman Sachs

Question again on the fixed income market. So Mark, going back to your comments about sort of bifurcation between Core and Core Plus in more specialized products. Can you talk about the competitive dynamic in one sort of market versus the other? Because if you go back a few years, the Core and Core Plus was dominated by you guys, Pimco and BlackRock. My guess is that the more specialized business are a lot more competitive. So on a net-net basis, as you're kind of having some product move from Core to specialized, it might be a net negative for you guys just from a competitive dynamic perspective. Can you talk about that?

Mark Fetting

I think there again, we have a view and Western has a view of game on. We have been purposely building out our specialized capabilities strategically for five to 10 years. If you think about we were a pioneer in the European business, in London in particular. We did an acquisition in Singapore with Rothschild, the Citi acquisition was very much attractive to us because 60% of the assets were fixed income and gave us on-the-ground investing capabilities, and client servicing capabilities around the globe. And all of that bolstered our ability to do specialized. So one of the reasons we put this chart in is to make sure everybody's aware of how well positioned Western is for that. Now you are correct that when you get in those specialized areas, you compete against more specialized firms as opposed to the kind of legacy big three Core Plus. But we think, in many ways, we're well positioned for both. Improved performance in Core, Core Plus will deliver more business for us even if the demand there is a little less going forward. It's a large institutional level, and specialized is an emerging opportunity.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Fetting for any closing remarks.

Mark Fetting

Well, I want to thank you all for your interest in Legg Mason. As you can see, we're very focused on growing our business across these three drivers of differentiation, best-in-class managers, a corporate center that delivers value and a balanced portfolio over the long haul across asset classes. We're going to do that with a great team of leaders, and I want to thank them and all of my colleagues and wish everybody the best. Thank you.

Operator

The conference has now concluded. Thank you for attending today's event. You may now disconnect.

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