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Legg Mason (NYSE:LM)

Q1 2012 Earnings Call

July 28, 2011 9:00 am ET

Executives

Mark Fetting - Chairman, Chief Executive Officer, President and Member of Finance Committee

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

Alan Magleby - Director of Investor Relations & Communications

Analysts

Craig Siegenthaler - Crédit Suisse AG

William Katz - Citigroup Inc

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

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

Michael Carrier - Deutsche Bank AG

Macrae Sykes - Gabelli & Company, Inc.

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

Marc Irizarry - Goldman Sachs Group Inc.

Daniel Fannon - Jefferies & Company, Inc.

Cynthia Mayer - BofA Merrill Lynch

Roger Freeman - Barclays Capital

Operator

Greetings, and welcome to the Legg Mason First Quarter 2012 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alan Magleby, Director of Investor Relations for Legg Mason. Thank you, sir. You may begin.

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 first fiscal quarter 2012 ended June 30, 2011. 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 Conditions and Results of Operations in the company's annual report on Form 10-K for the fiscal year ended March 31, 2011, 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 good morning, and welcome to our call. Overall, we are pleased with our results in the quarter. It was a quarter of real progress in most areas, including improved fixed income flows, diligence on expense control and successful implementation of a significant phase of our streamlining effort announced last year.

Let's start with this quarter's highlights on Slide 2. We generated net income of $60 million or $0.40 a share on a GAAP basis, which is up 33% from the fiscal quarter 2011. Importantly, adjusted income, which adds back certain noncash and other expenses is $109 million or $0.73 per share, up 22% year-over-year.

In June, we completed the second and most significant phase of our targeted streamlining cost reductions, and we successfully transitioned most of our shared services activities to our affiliates. The quarter's results also include the cost related to our second successful ClearBridge Energy MLP Fund, which raised approximately $600 million in just a 9-day offering.

In the quarter, Legg Mason reduced the level of long-term net outflows by 28% compared to the prior quarter and 35% compared to the same quarter last year. We experienced fixed income inflows for the first time since December '07, underscoring the momentum being built at Western, as well as positive inflows in the fixed income product at Brandywine and Permal. We continued our active capital management efforts, buying back 6 million shares in the June quarter and reducing our outstanding debt by approximately $100 million.

Slide 3 outlines assets for the quarter, which totaled $663 billion, down 2% from the prior quarter and up 3% year-over-year. The quarterly decline primarily reflects that certain liquidity assets went back to Morgan Stanley Smith Barney. It also reflects the divestiture of Barrett Associates of small wealth manager. As you can see, fixed income assets increased as a percent of AUM, reflecting higher fixed income market, as well as inflows. Equity assets declined slightly as a percent of AUM, reflecting lower market and a pickup in outflows. Average assets were down slightly for the quarter, reflecting the dispositions, while the effective yield improved slightly to just over 36 basis points.

Slide 4 shows net flows for the quarter. As I mentioned earlier, Legg Mason had positive fixed income flows for the first quarter since December '07 and positive liquidity flows excluding the disposition of the liquidity assets to Morgan Stanley. On the fixed income front, both Brandywine and Permal contributed to positive inflows, while Western again saw improvement in their level of outflow. Excluding the loan yield in Asian mandate, which we've highlighted for some time now, Western had positive flows for the quarter. There was an uptick in equity outflows for the quarter, driven by several large institutional reallocations at Capital Management, Batterymarch and ClearBridge. From an affiliate perspective, Royce, Brandywine and Permal had inflows for the quarter.

Slide 5 shows assets by affiliate in order of their contribution to pretax earnings. First is Western at $447 billion. This is down from $455 billion in the March quarter, primarily driven by the $18 billion disposition of money fund assets. And just a reminder, that there's another $5 billion to be transferred over the next 12 months. Next is Permal at $21 billion with its fifth consecutive quarter of positive net flows even with a previously disclosed restructuring of a single manager that resulted in a drop of $500 million. So they will continue to earn fees with the assets until the end of 2013. Positive flows are driven by continued momentum in the institutional channel, particularly in the U.S. In this channel, Permal has approximately $500 million in unfunded wins, and they are seeing longer-term opportunities in other parts of the world. Canada is one example, and the U.K. is another, where they recently hired the first head of their U.K. institutional business. They're also seeing momentum with high net worth investors in regional banks, particularly in Europe, the Middle East and Singapore. They're also going after opportunities in China, including the hiring of China expert Professor Zhuwi (sic) [Zhiwu] Chen to serve as a global advisor. Royce, at $43 billion, had modest positive net inflows offset by market declines in the small cap sector. Our efforts with Royce in our international distribution platform continued to show strong results in Europe. Interest is also building in Asia. ClearBridge, at $57 billion, is down slightly, primarily due to rebalancing by clients, including approximately $400 million due to reallocations at a few institutional accounts. This is partially offset by the Energy MLP closed-end fund raise and an insurance sub-advisory mandate in the Aggressive Growth Fund.

The ClearBridge Opportunity Fund is our second MLP closed-end fund over the past year. In total, we've raised approximately $2 billion in this space with ClearBridge. The Legg Mason ClearBridge Aggressive Growth Fund is top-ranked in both its Lipper MorningStar categories over the 1 and 3-year periods. Batterymarch is just under $23 billion. Two accounts partially allocated away for a total of approximately $900 million. Its investment models are continuing to produce positive performance, and the firm is again seeing interest in their systematic strategy, particularly in their smaller cap strategy covering the U.S., international and emerging markets. Batterymarch funded 2 new clients during the quarter in their emerging markets strategy, totaling over $200 million. Additionally, 2 existing accounts clients have either funded or pledged to fund significant further assets totaling over $500 million into their international small cap and [indiscernible] strategy.

Legg Mason Capital Management ended the quarter at approximately $12 billion. The decline in assets is driven by a $1.6 billion termination by a low-fee client. While performance remains challenged in certain time periods, we recognize that these markets have not rewarded valuation-driven managers. Capital Management management team is focused on asset retention while positioning for growth with new products and expanded leadership for some of their senior investment professionals. Their strategies do represent a purposeful bet by their clients for an eventual shift in sector leadership.

Finally, Brandywine is at nearly $33 billion, with positive flows in the quarter in both equity and fixed income. We worked with Brandywine to seed 2 absolute return products in the quarter, and we are seeing momentum in retail share classes added to their institutional global bond fund in '09 and '10, as well as in the diversified large-cap value fund launched in September '10.

Slide 6 shows an update on the Western assets. They continue to see interest in specialized mandates, which accounts for nearly half of their Assets Under Management. For the quarter, assets were up for almost all of Western's offices. And AUM in Brazil, Singapore and Australia is at an all-time high. More than 3/4 of their composite assets are beating benchmarks for the 1, 3, 5 and 10-year periods, showing the strong progress they've made with investment performance. In recent article, intentions and investments highlighted Western's successful recovery. The chart on the bottom shows fixed income flows for Western, showing their progress from the financial crisis to today. Total fixed income flows for the quarter were almost breakeven, driven by continued interest in their specialized products. This was more than offset by $2.7 billion in outflow from the low-yielding mandates that we have referenced in prior quarters. A key point here is that outflows from lost accounts at Western are at their lowest levels since the December '06 quarter. Unit flows trended favorably this quarter, and very talented and respected senior managers were added in Singapore, London and Pasadena.

Slide 7 shows the continued performance improvement. This quarter, we changed our performance view to composites as this is a better reflection of the total AUM we managed, including institutional business. As you can see, our long-term performance numbers are strong, with just under 90% of assets beating benchmarks over the 10-year period, approximately 75% over the 3 and 5, and about 70% over the 1-year period.

Slide 8 shows an overview of our global distribution businesses. As we combined the Americas and international businesses into 1 unit earlier this year, we are now showing the consolidated numbers in addition to breaking out U.S. and international. Total assets in our distribution growth business globally, which is comprised of retail, instividual and selected international institutional markets is approximately $228 billion. Approximately 43% of those assets are in the U.S. retail channel and 35% in U.S. instividual. The remaining 22% is in international, which we believe represents a significant growth opportunity for us as we have had 10 consecutive quarters of positive flows in that business. If you look at distribution by affiliate, it is led by Western, ClearBridge and Royce.

Slide 9 shows the progress being made in U.S. sales. This was the first quarter of positive flows in 5 quarters, driven primarily by sub-advisory wins for Western and Batterymarch, the ClearBridge Energy MLP and the retail takeover win in the independent channel. Gross sales increased 11% over the prior quarter. There is a continued trend of further diversity here as the investment advisor channel now represents over 30% of total retail sales in the quarter. 60% of total sales in the U.S. now come from partners other than Citi and Morgan Stanley Smith Barney. We are excited for our plans for global distribution. Just this week, Joe Sullivan and his team rolled out a new organizational structure in the U.S. that is designed to flatten the sales team by eliminating layers and adding more sales people in front of advisors over the next several months. The net expense impact is favorable. We will expand our coverage of advisors across all channels and geographies in the U.S., as well as deepen the strong relationships we currently enjoy.

Slide 10 shows our international distribution long-term sales trends. As you can see, we now have had 10 consecutive quarters of positive flows. Flows for this quarter were led by Western and Royce products, but we are starting to see inflows in the Permal fund. Now let me turn it over to Pete.

Peter Nachtwey

Thanks, Mark. Clearly, in the first quarter, we were faced with some choppy markets. But overall, we continued to make significant progress in streamlining our business model with the aim of reducing expenses while increasing our operating margins and our net income. As I indicated last quarter, fiscal 2012 will be somewhat fluid with significant transition cost hitting certain periods and underlying savings ramping up throughout the year. But this will result in some lumpy quarters largely due to the timing of transition cost recognition. For the current quarter, a number of factors impacted our P&L. This included the previously discussed step-down in Western's reimbursement, the incurrence of additional streamlining cost, the launching of a new closed-end fund and the deployment of some of our excess capital. But at the end of the day, the quarter's results reflect a modest increase in revenues and our continued focus on tightly controlling expenses.

Now let's turn to Page 11 to review the financial highlights for the quarter. As Mark noted, first quarter 2012 net income of $60 million resulted in $0.40 in earnings per diluted share, which included the impact of $14 million in transition costs and $11 million in costs associated with the ClearBridge closed-end fund launch. Together, these reduced our diluted earnings per share by $0.11. Operating revenues were up 1% compared to the prior quarter due to an additional billing day and a slightly higher advisory fee yield that more than offset lower average AUM and slightly lower performance fees. Also, as we highlighted on last quarter's call, $16 billion of liquidity sweep assets were transferred to MSSB in early April. In total for Q1, close to $18 billion of sweep assets were ultimately transferred. Though the bottom line impact of these transfers was de minimis, they do have a sizable optical impact on our AUM for the quarter. This transfer also reduced revenues despite the fee levers [ph], but after the dual impacts of our revenue share arrangement with Western and the reduced distribution servicing costs associated with these funds, there was little bottom line impact. As an example, in the current quarter, it works out to $0.01 per share.

Operating expenses were slightly higher due to the $11 million impact of the aforementioned closed-end fund launch, as well as the impact of the Western step down of $16.4 million. I'm going to more detail on the expenses in a bit. The adjusted income for the quarter was $109 million or $0.73 per diluted share. As you can see in the schedule on Slide 12, our effective tax rate for the quarter was 31%, in line with the prior quarter but down from our previous guidance of 35% to 36%. The lower rate this quarter resulted primarily from one-off adjustments of valuation allowances and reserves. Also, I want to point out after careful study, we're dropping our longer-term tax rate guidance 1% to a new range of 34% to 35%. This reflects the benefits from some permanent rate reductions in certain jurisdictions and the impact of some tax planning work done by our internal compliance group. However, for fiscal 2012, we expect our rate to be even lower in the low 30% range, reflecting the one-time impact of another recently enacted U.K. rate reduction on the value of our deferred assets and liabilities. We expect to recognize an $18 million benefit for this U.K. item in fiscal Q2.

Turning to Slide 13. We continue to see improvement in the advisory fee yield this quarter. However, the pace slowed due to a number of factors. First, as a percentage of AUM, our higher fee equity assets declined from 28% to just above 27%. As Mark mentioned earlier, this was caused by the triple impact of our first positive flows for fixed income since the December 2007 quarter; the pickup in equity outflows, which was an industry-wide phenomenon in the June quarter; and on the performance front, fixed income markets were up, while equity markets declined during the quarter. Still, our average advisory fee yield for the quarter at just above 36 basis points was the highest since the September 2008 quarter and up from 33 basis points a year ago.

Flipping to Slide 14. Operating expenses for the quarter increased slightly due to the Western step-down and the closed-end fund launch cost, partially offset by comp expense reductions in non-revenue-shared business units and a number of one-time costs in the other expense category in Q4 2011. Some of these items impacted the comp and benefits lines, which I'll speak to on the next slide.

Focusing on distribution and servicing, 2 events impacted this line item for the quarter. First were costs related to the closed-end fund launch of which $9.8 million is in DNS expenses, with the bulk of the remainder going through comp and benefits. In addition, due to the transfer of sweep assets this quarter, not only did our revenues decline, but our DNS expenses also declined by approximately $7.6 million. Communications and technology expenses decreased due to system conversion costs last quarter relating to our streamlining initiatives and the quarter's other expense line included the cost of a one-time assessment by the U.K.'s financial services authority related to the recent financial crisis, as well as costs related to consulting, accounting and other professional service fees which did not repeat in Q1.

The GAAP comp and benefit highlighted on Slide 15 were basically flat quarter-over-quarter. But excluding transition-related costs and the mark-to-market on deferred comp and seed investments, our comp and benefit and net revenue ratio came in at slightly above 56%, reflecting the $16.4 million charge related to the Western step-down. Last quarter's comp and benefit costs included seasonally higher payroll taxes and the benefits, as well as higher incentive accruals, while this quarter's results included a higher payroll taxes related to our fixed fiscal year bonus payments in May. Salary and incentives included $1.4 million of commissions related to the closed-end fund launch. Adjusting for the expenses related to this launch would reduce the comp ratio by 1% due to the impacts on both the numerator and denominator. We expect the comp to net revenue ratio to decline from the current level as the benefits from streamlining initiative begin to flow through the P&L. We anticipate next quarter's ratio to drop to 54% and the bottom out in the near-term in the 53% to 54% range once the streamlining is complete. As we grow revenues into the future, we anticipate that the comp ratio will trend downward slightly as we hold the line on corporate and admin expenses, and as Joe Sullivan's distribution team continues to find economies of scale as we ramp up their sales machine.

Turning to Slide 16. The decline in the first quarter operating margin reflects the combination of the Western step-down, as well as the costs associated with the closed-end fund launch. Excluding the impact of the closed-end fund clause, our operating margin as adjusted would've been 1.7% higher. As we think about next quarter, our expenses will benefit from the June 30 headcount reduction. The next quarter's expenses will also include the full $80.5 million for the Western step-down or $2 million increase from the current quarter. Also, in the September quarter, we will have seasonal costs related to corporate governance, as well as the advertising expenses around the Legg Mason Tennis Classic, which together total about $3 million.

Turning to Slide 17. We are now 1 year into our streamlining initiative with less than 6 months to go. In the quarter, we realized $9 million in total savings. And, as I mentioned earlier, to date, we have achieved $36 million in annualized savings while incurring $68 million in transition-related costs. June 30 was a major milestone in our streamlining initiative as we seamlessly completed the migration of systems and transfer of functions to affiliates as planned. Both post-June 30, from an affiliate perspective, the only activity left to complete is the handoff of archived data. With the transfer to affiliates complete on June 30, we made our second major reduction in force, this one being the largest scheduled reduction in headcount from our streamlining initiatives. To date, we transitioned 300 employees, the 20% of our March 2010 staffing levels, with an additional 115 transitions planned to come on December 31, 2011. We're estimating that we will incur approximately $60 million in transition-related cost in the next 2 quarters with $15 million of that in fiscal Q2. Also in Q2, we expect to realize $25 million in total savings, resulting in $100 million in annualized run rate savings, as all of our headcount reductions for the quarter would have been made as of June 30.

As you can see on Slide 18, the impact in our GAAP financial results in fiscal 2011 was a negative $42 million. In fiscal 2012, we expect a positive net GAAP impact of approximately $20 million. This reflects our projections that the current year's transition-related costs will be more than offset by realized expense savings in fiscal 2012. And ultimately, we expect to achieve our full $130 million to $150 million in run rate savings by fiscal Q4 2012. Though the quarterly ups and downs will be a bit choppy, the savings will start to pick up in fiscal Q2.

Slide 19 depicts share repurchase activity through June 30. As you can see, we repurchased $200 million of shares this quarter. This means we have now repurchased 20.6 million shares or 13% of our outstanding shares as of March 31, 2010. At this point, $355 million remains of the original board repurchase authorization of $1 billion. As I've discussed last quarter, we plan to accelerate our share repurchases over the upcoming fiscal year due to the compelling value that we see in our shares. Specifically, we plan to repurchase an additional 200 million by the end of fiscal 2012, subject to market and company performance, actual cash flows and other capital needs. In terms of other share activity in the quarter, in addition to the 200 million in repurchases, we issued approximately 1.2 million shares of stock in May related to our annual incentive awards. Since this occurred halfway through the quarter, only about half of those shares are reflected in this quarter's weighted average share count. In addition, on June 30, we retired the remaining 103 million of our equity unit debt, which led to the issuance of an additional 1.8 million common shares on that date. These will be reflected in our fiscal Q2 average diluted share count along with the remaining 600,000 share impact on the average from the May incentive awards. Both of these will be more than offset by the 4.1 million share impact on the average related to the fiscal Q1 repurchases, which were weighted towards the end of the quarter.

Before I turn it back over to Mark, I wanted to provide you an update on our outlook for fiscal Q4 2012. Although it is not our historical practice to provide guidance as to expected future results, given this is our key turnaround year, we decided last quarter to give you an idea of our expectations for Q4. While I'm pleased to report that we remain on track to hit projected fiscal Q4 earnings per share within the core consensus range of $0.55 to $0.65 per share. So at this point, thanks for your time, attention and interest in Legg Mason. And now, Mark, back to you.

Mark Fetting

Thank you, Pete. Turning to Slide 20, let's summarize our progress this quarter. Earnings were strong. We had improving and positive fixed income flows. We launched another successful closed-end fund raising nearly $600 million in assets. We successfully implemented a significant phase of our streamlining effort. We repurchased an additional 6 million shares of stock, reduced debt and ended the quarter with approximately $850 million in available cash. Near-term, we have to be mindful of choppy market and industry conditions with domestic equity fund outflows, a slowdown in institutional equity flows and global concerns around sovereign debt issues, not only in the eurozone but in the U.S. as well. However, it is our belief that the big issues will ultimately be resolved, and we are working with clients, distribution partners and consultants to restore our focus on what is happening out there, which is recovered fundamentals, and therefore, returning confidence in capital market opportunities.

Going forward, our priorities are to support our affiliates on client performance and franchise expansion. With performance improvement in fixed income, we would expect our recovery to continue in this essential asset class. Within our equity business, we should see continued distinction in a number of our affiliates, while others work through some challenges. And clearly, alternatives are much in favor, and we are in a position at Permal to continue to share net growth to the global expansion of both our institutional and retail channels. We will accelerate their growth through global distribution, and we will complete our streamlining on time and on budget in March '12. Finally, we will continue to deploy capital to enhance shareholder value.

And now, we look forward to taking your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Robert Freeman with Barclays Capital.

Roger Freeman - Barclays Capital

I guess, this was in respect to the Western flows. How broad-based is that actually? Can you -- I'm not sure we had this -- can you walk through redemptions and exclude the sovereign mandate that had been coming out, but just redemptions and inflows separately, so we can see at the trend in there? And then just, has it been concentrated mandates that are funded or more broader-based?

Mark Fetting

Yes, Roger. The thin line is a pickup in sales activity that's quite broad-based both globally and across mandates and a continued reduction in the redemption side, particularly noting that those closed accounts are down to the level of really pre-crisis. So we're very encouraged. This quarter did include some significant wins that have been in the pipeline. So the pipeline going forward is still strong, but probably in terms of near-term funding, not as large just because of those, and big wins that happened this quarter. But the other indicators of activity in terms of proposals and final presentations are all on the uptick.

Roger Freeman - Barclays Capital

Okay. So I guess, my follow-up question would be, you maybe size a maybe notional, how many -- where you've gone in terms of RFPs that you're competing for, let's say, now versus a year ago? And also what your win rate is now versus a year ago?

Mark Fetting

Our basic -- I don't have it kind of an exact number, but I would say meaningful improvement in addbacks. And the win rate is now moving into kind of a reasonable level. And, as you know, Western in its over the long haul has been really high at the 50% plus range, which is very, very high. And they're getting into the lower end of the range, which they haven't been -- almost from 0%. So it's improving nicely.

Roger Freeman - Barclays Capital

And July trends in Western have been similar?

Mark Fetting

Absolutely. And to be honest, one of the areas of victory here has been getting back and taking some business from some other key members -- key competitors out there that normally have gone the other way.

Operator

Our next question comes from Bill Katz with Citigroup.

William Katz - Citigroup Inc

In reference to some prudent dispositions, I'm just curious that as you look around the rest of your portfolio, and you look at that page where you have the contribution earnings by affiliate, I'm wondering if your words swipe from the bottom up. Are there any affiliates here that are maybe suffering some SIV outflow that might have a better value outside of Legg Mason?

Mark Fetting

Thanks, Bill. Can you kind of push that a little further? I want to make sure I understand exactly the question.

William Katz - Citigroup Inc

I guess a more direct question is, would you be willing to sell or otherwise dispose of Legg Mason Capital Management, which continues to be an anchor on outflows and profitability?

Mark Fetting

Now we -- as I stated, there's clearly been -- what they've lost is a significant account, but that account was really making kind of allocation call across their model. The remaining clients there, I think believe strongly as do we, that they are making a bet towards some sector change in the market. And tech, financials, healthcare right now, they're over allocated too. It's costing them short-term performance, but there are a lot of clients in there that think that, that could reverse, should reverse, and would actually bode well for them and get back to the long-term returns that they've delivered for clients.

William Katz - Citigroup Inc

Okay. And just a follow-up question in terms of some of these global distribution issues, I'm sort of curious, where most immediately would you anticipate seeing a little bit more of pick up here? Is it in sort of WAMCO or Royce? Or are there other sort of opportunities out there that are developing?

Mark Fetting

I would first talk about the global piece and international continuing to be quite strong. In the Asia businesses, a lot of which flows to global distribution, we're really seeing that at Western, at Royce, and even Batterymarch, in terms of systematic investing returning, a good pickup. Permal is also benefiting though they do most of their work directly. In the U.S. markets, we see the opportunity for large-cap equity, dividend oriented, equity and income oriented. At ClearBridge, to be picking up, as we get through this choppiness right now, I think, you're clearly seeing everybody kind of pull back a bit. But we still remain confident that there's some good opportunities there. And as they say, we get through these choppy issues right now, there's a focus on the restored fundamentals that are occurring in terms of company performance, and people get back the confidence in the market, and we got products that can deliver on that.

Operator

Our next question comes from Cynthia Mayer with Bank of America Merrill Lynch.

Cynthia Mayer - BofA Merrill Lynch

Looking at Page 13 of your presentation, your advisory fee is rising, but do you have a sense of what that would be excluding the money market disposition? And I guess, basically, what's the fee revenue average trending like for long-term assets at this point and that includes for assets coming in?

Peter Nachtwey

So the impact on our yield this last quarter was across kind of the whole spectrum. So equity was down both from a flow and a market standpoint. Fixed income was up, and liquidity stands to Morgan Stanley. Sweep assets moving was also up. So in terms of the impact on the margin, most of that's already reflected. In terms of this specific liquidity, most of that's reflected in the yield at the end of June 30. It's a little tough for us to predict it going forward because again, it's going to be subject to going out of the markets and outflows go in the future.

Mark Fetting

Cynthia, one thing that I can add on this is just tracking on the products that are gaining favor and showing good flows. Generally, those products are coming in with higher yields, reflecting the trends with specialization versus some of the areas where we're seeing outflows.

Cynthia Mayer - BofA Merrill Lynch

Great. Yes, you've noted that before for Western, so that's continuing?

Mark Fetting

Yes.

Cynthia Mayer - BofA Merrill Lynch

okay. And then I guess, on that note, same thing -- same question with the composite performance on Page 7. It says it includes liquidity. Can you give us a sense of what the numbers would look like x liquidity?

Mark Fetting

Yes. It does include liquidity and it's kind of a little lower, but still generally quite strong.

Operator

Our next question comes from Michael Carrier with Deutsche Bank.

Michael Carrier - Deutsche Bank AG

I think, first question, you might have touched on this, but just on the ongoing outflows at Western, just from some of the larger sovereign wealth mandates, just any update there? And then on the equity side, I guess I'm just trying to maybe back into, you said Royce, I think Permal and then maybe Brandywine had inflows. And then you pointed out the one lumpy outflow at Legg Mason Capital Management. But when I look at the overall outflow, it just still seems on the elevated side. I just wanted to see if there was anything else in there. And then probably more importantly, just when you look out, talking to the sales force, the clients, what's the outlook on the equity side, as well as on -- I know you touched on the Western side, but really on the equity side?

Mark Fetting

Let's go first to the Western question. Remember, that's a mandate to invest in sovereign wealth paper. It's not a mandate from a sovereign wealth client. And we did say in the text that it's -- this quarter came in at $2.7 billion, which is a bit lower than prior quarters, so we are seeing some improvement there. Here again, the shift there is quite pronounced in that Asian market where we're offsetting that very low fee business with some very robust and more favorable fee business with specialized mandates. If you go to the equity questions -- what was the second one, the second question? I want to make sure...

Michael Carrier - Deutsche Bank AG

Yes, just on the equity side, the overall outflow that you pointed was like $5.8 billion. And you pointed out the $1.6 billion. And when I look at the components in terms of all the different affiliates, it looks like you have -- you mentioned like Permal, I think it was Brandywine, and then Royce have an inflows. And then obviously you had outflows in the other areas. But I just wanted to know if there was anything else that was lumpy because the number still seems a bit high relative to having inflows in some of those other affiliates?

Mark Fetting

Right. And what we tried to do is kind of hit that in 3 levels, so let me tell you: One, in terms of your lumpiness seem certainly the $1.6 billion at Capital Management to almost $900 million at Batterymarch, and the approximately $400 million at ClearBridge, we see as special situations that ought to be kind of acknowledged in a not kind of day-in, day-out kind of activity, institutional, sub-advisory reallocations by large refund benefit plans, et cetera. The next level I would say, certainly in June, as the industry experience was a pickup in outflows in response to equity market conditions. And that has continued a bit in July, as you would expect, but that's more the normal industry pickup. So then I think that leaves you with a level of equity outflows that is certainly manageable and it represents probably work that's being done by the management teams at Capital Management. And ClearBridge, in particular, just keep working on turning that around.

Roger Freeman - Barclays Capital

Okay. That's helpful. Then maybe the follow-up for Peter, just on -- just trying to put this together when I look at the streamlining and where we are this quarter versus next quarter. It looks like you recognized $9 million of the savings, and that's going to pick up to $25 million next quarter, so a delta of $16 million. But I think then, just partially offsetting that, it's sounding like seemingly, you expect $3 million of expenses -- of higher expenses kind of in a non-comp. And then on the comp, I think it was maybe like $2 million. I just wanted to make sure I'm kind of putting all those numbers together fairly accurately. And then thinking on the share count, when you look at what's coming in and what's going out, it looks like still net-net, the share count will be down somewhere between like 1 to 2 million shares as we go into the next quarter, all else equal.

Peter Nachtwey

Michael, first of all, thanks for a question that you pretty much answered, so great job. But we'll absolutely agree with -- you got all the numbers right in terms of the things, next quarter, the $2 million uptick on the -- that Western step down, and then that flattens out at that level. And then the $3 million on the kind of one-time cost next quarter that again won't recur the following quarter. And I agree with your share count in terms of where we end up, kind of at the 148 million or so.

Roger Freeman - Barclays Capital

Okay. So on the expenses, if you net all that, you're still looking at somewhere around, sequentially, obviously, depends on what happen in the quarter, but a decline of around $10 million?

Peter Nachtwey

In terms of expenses next quarter, that sounds about right. I think Mark probably is going to add some color on this too.

Mark Fetting

Actually, I just want to go back to the equity piece, just to clarify, the question he raised about the equity flows. Permal technically was negative in outflows, but as you recall, we had that $500 million. So you back out that $500 million, they're positive. So on a go-forward basis, going back to your key question of kind of equity, we certainly see Permal's equity-oriented strategies as something very attractive in these kind of market conditions. We've seen that large-cap equity systematic at Batterymarch. We don't expect the small-cap contributions that we've had in the past that Royce is to continue. And in fact, if you just look at near-term data, certainly that's an area that, industry-wide, has moved into some outflows.

Peter Nachtwey

And Mike, I just want to add on the expense side, I think you kind of got it right on the corporate admin side. Just keep in mind, things could be impacted if we do another closed-end fund launch and also depending on our affiliates or where revenues come from. So if we had a lower rev share affiliate that really uptick in terms of revenues, more of that will go to their comp line. But on the corporate side, I agree with the number.

Operator

And the next question comes from Craig Siegenthaler with Credit Suisse.

Craig Siegenthaler - Crédit Suisse AG

Just on the 4Q guidance, is that excluding any integration expenses that you may have?

Peter Nachtwey

Effectively, all of our transition costs should be completed by the end of the third quarter. So fourth quarter is kind of one we're looking at as the first clean, post-transition cost.

Craig Siegenthaler - Crédit Suisse AG

Got it. And then on the expense initiative of $130 million to $150 million kind of target here, how much has been realized by June 30? And I'm guessing we should expect another $25 million by September 30 given that disclosure on -- in the slide deck.

Peter Nachtwey

So on a run rate basis, at the end of this past quarter, we're at $36 million on the annual run rate basis. And then next quarter, we expect that run rate on a quarterly basis to go up by $16 million to have a total of $25 million on a run rate basis -- on a run rate quarterly basis on $100 million on an annual run rate basis.

Operator

Our next question comes from Dan Fannon with Jefferies.

Daniel Fannon - Jefferies & Company, Inc.

Just a follow-up on Permal, it seems like you have positive flows for the quarter. But wondering if there's been any change, or you're seeing any change in the distribution channels where there was the recommendation changes by the wirehouses? There's been any kind of flow pickups or -- I mean, outflow pickups as a result?

Mark Fetting

Yes, Dan. We have continued to work with just a few, and I want to emphasize that, a few arms that raised some issues for review. And we're pleased that there was really very little kind of ripple beyond that. In those few, we have seen in one some outflows to be expected but manageable. And broader-based, we're very encouraged by the reception of the broad investing community in terms of Permal's products, their interest now and going forward. And so we think this combination of on the institutional side, the retail side that the net momentum continues to be strong.

Daniel Fannon - Jefferies & Company, Inc.

Okay. It's helpful. And then I guess, Pete, in terms of some of the assumptions as you think about the progression to get to the fourth quarter earnings number, are you assuming any material improvement within either equity or fixed income flows?

Peter Nachtwey

We effectively are anticipating outflows for the year, as kind of what's in our multiyear plan across the patch. And then on a market standpoint, we've got what I would call moderate or below what I call long-waved averages in terms of market performance. So we do expect the market to continue to improve in general but at a moderate rate, so that would have an impact on the equity side, as well as across the other 2 asset classes.

Operator

Our next question comes from Jeff Hopson with Stifel, Nicolaus.

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

So, Mark, the restructuring on the sales side, it seems like significant number of changes that have occurred and will occur, but it doesn't sound like you expect any effect on near-term sales. Can you comment on that?

Mark Fetting

Well, I think in terms of near term, obviously, if you're talking about just -- you announce a reorganization like this and next month, you're going to see a delta tied explicitly to that, I think that's good caution. Medium to longer term, we're very encouraged by the opportunity to take what has been a productivity level measured against peers as good and can be taken to great. And the way to do that is -- thanks to Joe's leadership, is really to kind of remove some levels that are away from client facing, shift some folks in terms of the dedication of external and internals, but more out in the field in front of clients and advisers. And we think that will bode well. So that, combined with market conditions improving, getting back to kind of investors seeing the improved fundamentals, we think that bodes well.

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

Okay, so there could be a slight effect in the very short term. But obviously, you think...

Mark Fetting

Yes, I think anytime you go through a change like this, Jeff, you kind of acknowledge one thing I what I did say is these changes are kind of modestly favorable from an expense side. So this is not kind of us increasing our spend, it's redeploying our resources. And then we would expect that to kick in with better productivity. That, plus the market environment improvement, we think bodes well in U.S. retail and then continued good momentum in the international side.

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

Right. Okay, great.

Operator

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

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

First, can you just talk a little bit about maybe some of the drivers of the improvement in performance trend at WAMCO? Is it more on kind of the Core, Core Plus side? Or is it on a specialized mandate side? Or how broad-based has the performance improvements been?

Mark Fetting

Mike, it's really been across-the-board. Certainly, it starts with Core, Core Plus. And you see that in terms of the flagship funds and the records that they have, which are very strong on $135 million, and importantly, compared very favorably with competitors' flagship funds in that arena. So we're getting back into platforms that previously we had been taken off of, so that's a big plus. On the specialized side, it's really across offices. Certainly in Pasadena, specialized business is in good momentum. In London, where we do some international products, some of that team, which I actually acknowledge is being kind of best in the business for the past year or so. In Singapore, we have an agent bond product that's done well on a team approach. And then as we said, Australia and Brazil are at record levels, and we've leveraged that capability into other markets.

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

Okay. And then maybe just a little color in terms of how you're thinking about new products come into market looking forward, and then more specifically, as it relates to potential closed-end fund, IPOs. I think you -- last quarter, you mentioned kind of a number that were in the works.

Mark Fetting

Yes, in the closed-end side, we have 2 concepts that we're very encouraged by. One theme would be kind of some fixed income products with 2 of our managers that we're talking about and prepared to move on. And then the other is on the alternative side with Permal. At a certain stage, we got to go quiet as we get into registration and get on the calendars and that we're approaching that very soon. Product development, more broadly, is a area of real pride for us because I think we've worked very closely with the affiliates and -- both in international markets and U.S. launched some excellent products. So I think that will continue, and it's a high priority, as I mentioned in the close.

Operator

Our next question comes from Robert Lee with KBW.

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

Maybe just following up on talking about some of the new products, and as that relates also to Capital Management, if I think about the remaining buyback, that's 200 million more stock balance this year, I think your current requirement, that would suggest that you continue to build cash actually, I think, over the balance of the year. Is part of the -- if you see here and now, you have a lot of new products on kind of the drawing board, I mean, is part of your thinking that you'll need to have a step up and kind of seek capital in the next couple of months to fund some of these? And I assume it’s happening already as well?

Mark Fetting

Well, as you know, we have over $400 million invested in SIV investments on the balance sheet, and we do see that growing. We do want to work closely with the affiliates in terms of where we can rotate. Some of the investments there, we think, can be harvested and redeployed. But we definitely see that number growing. We haven't put any explicit guidance on that. It has been beneficial to make those investments. And it ranges from bigger chunks in the alternative space with Permal as an example. We helped the launch at China Fund that has attracted very good institutional following. It truly wouldn't happen if we didn't do that. It's probably an opportunity for other initiatives. So I see it across the affiliates. I see you want to continue to look where we can rotate. But it'll be a net plus. We'll keep you posted.

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

And I'm just curious, I know you've more institutionalized kind of process for looking at new product ideas on allocating seed capital. I'm just curious as, given your kind of revenue sharing arrangement to what not, I mean, do the -- have you decided on Permal going to seed $30 million of strategies. Is there an effective clause to Permal for the use of that capital for some period of time? Or is that -- I'm just curious how you think about that.

Mark Fetting

Yes. Now we actually and Pete has spearheaded a review of our seed capital allocation policy. We do charge for the cost of the capital, and then we look forward to making it more uniform. But, Pete, you might want to...

Peter Nachtwey

It's a good question, Robert. So we look at returns on seed, that the primary return is coming from our future revenue generation. So if we can seed something with $1 million or $10 million of corporate money, it turns into a $500's million or $1 billion fund down the road, the returns on that dwarf any returns on the -- just the immediate deployment of capital. So that's what we're playing for. But the affiliate kind of makes some investments want -- we try and encourage them to put side-by-side investments almost in a private equity kind of model. And they also invest some blood and sweat because they're incurring all of the compensation cost to their people that are spending time on this. So we think there is a pretty fair sweat of the investment and then ultimately, the return down the road which are what reshare [ph] model means. If they will keep their share going into comp long term, and corporate and shareholders will get our share.

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

Great. And just one more quick follow-up on -- this is on the ClearBridge. I'm just curious, trying to feel for existing AUM base, how much of that is still kind of a legacy wrap separate account business, which I'm assuming, maybe incorrectly, but kind of assuming that, that's still facing some attrition just because of maybe its concentration within Smith Barney, but any color on that will be helpful.

Mark Fetting

Well, the SMA business represents roughly 1/3 or so of their assets, and that's down as a percentage. And in that business, as you know, there's a rotation going on in terms of moving from what was the legacy MBA product, which ClearBridge's team were really pioneers doing more open architecture UMA product, and we're working hard to make sure we've kind of mapped into that. That's -- in some cases, that's a bit of an uphill challenge. In other cases, we've made some good progress, so that's an ongoing challenge. I tell you one area that's come back nicely is where we have managers, we built a fund and just conditional stand-alone SMA product, we're getting good flows. So Richie Freeman's aggressive growth fund is -- always have an SMA capability. And through this period of this improved -- not just improved but this really strong performance being punctuated, both areas are showing good progress, which is great.

Operator

Our next question comes from the Mac Sykes with Gabelli & Company.

Macrae Sykes - Gabelli & Company, Inc.

Since you've been conducting this restructuring, have you identified more potential for efficiency gains? And I guess, any thoughts on your thinking being impacted by the sort of a change of asset mix over this time?

Mark Fetting

Well, I think, rest assured, that we will be on a mode of continuous improvement around effectiveness and efficiency. And while we're not putting any incremental guidance in place, we're not going to stop on both fronts. And in the distribution commitment that we've done, the near term is how do we redeploy the existing spend to get better productivity. And we'll be monitoring that throughout. And as it relates to corporate costs, which is the other big chunk of our kind of discretionary spend, if you will, outside of the affiliate, there too, we're going to keep tracking, measuring against peers and making sure we're as effective as we can be. And we just -- our ONT, our technology team has been kind of putting forth incremental initiatives that acknowledge that where we can do more utilizing external leverage, let's do it. And I think that was a hats off to them as an example.

Macrae Sykes - Gabelli & Company, Inc.

And with respect to Permal, alternative performances had a wide dispersion this year. Can you give us some color on how performance fees are tracking for the December quarter?

Peter Nachtwey

Can you repeat the question, Mac, please?

Macrae Sykes - Gabelli & Company, Inc.

I'm saying the performance for alternatives has had -- the attribution of some funds have done pretty well, some have done not so well. I was curious as how the performance fees at Permal may be tracking over the half year?

Peter Nachtwey

Yes. They've been strong. Actually, interesting enough, last quarter, Western was our star in terms of performance fees, so we get them from several of our affiliates. But taking up Permal's were strong, but keep in mind, they've got a higher equity component. The equity markets were a little bit wild. The way they lock, and we've got fees that lock on a quarterly basis, we've got some annual fees that lock at quarters other than 12/31. And then 12/31 is still going to be a slightly bigger quarter. But in general, they've got about 85% of their assets. I think they're within shouting distance to a high watermark, either above or right at. So I think they're positioned well. They continue to generate some performance fees with some help from the market on a go-forward basis.

Operator

Our final question comes from Marc Irizarry with Goldman Sachs.

Marc Irizarry - Goldman Sachs Group Inc.

Can you put a little dimension around the institutional pipeline for Western, sort of how it compares this quarter versus last maybe?

Mark Fetting

Yes, Marc, in terms of kind of commitments not funded, it's down a bit just because we had a couple of lumpy wins this quarter. On the other hand, the other activity measures, proposals, finals, and as previously noted, improving win rate in those finals were encouraged. And that, we see, is meaningfully up year-over-year and also quarter-over-quarter.

Marc Irizarry - Goldman Sachs Group Inc.

Okay. And then just can you talk about retail outflows for Western and Core and Core Plus, how that's been trending over the past several quarters given some -- maybe some dislocation that's out there?

Mark Fetting

Yes. We've seen -- they kind of swing, but are consistent with the industry. And I think the magic question right now is, with clear evidence of people near-term withdrawing from equities, do they come back into the fixed income categories as they've seen, if that's the case, Western should bode well because the performance is much stronger. Their ability to sustain a big case in share in those systems is good. Obviously, in this environment, the flows coming into those fixed income products are positive.

Mark Fetting

Okay. Well, I want to thank everyone. As you can see, we're proud of the progress we've made, but we're also determined to continue delivering and very focused on the March '12 quarter and beyond. I urge all of us to active leaders as we go through these challenging times. The more we can lead constructively, get the issues resolved whether it's in Washington and restore confidence to the market, getting them to focus on the improved fundamentals that are in fact happening out there company-by-company, the better off we're going to be as investors and certainly as an investment provider. Thank you all very much.

Operator

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

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