Legg Mason's CEO Discusses Q2 2012 Results - Earnings Call Transcript

Oct.27.11 | About: Legg Mason (LM)

Legg Mason (NYSE:LM)

Q2 2012 Earnings Call

October 27, 2011 8:30 am ET

Executives

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

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

Alan F. Magleby - Director of Investor Relations & Communications

Analysts

Michael Carrier - Deutsche Bank AG, Research Division

Neil Stratton - Buckingham

Cynthia Mayer - BofA Merrill Lynch, Research Division

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

Macrae Sykes - Gabelli & Company, Inc.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

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

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

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

Roger A. Freeman - Barclays Capital, Research Division

Operator

Greetings, and welcome to the Legg Mason's Fiscal Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Alan Magleby, Head of Investor Relations and Corporate Communications. Thank you. Mr. Magleby, you may begin.

Alan F. Magleby

On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the second fiscal quarter 2012 ended September 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 condition and results of operations, and 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 the 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 Raymond Fetting

Thank you, Alan. Good morning, and welcome to our call for the September 30 quarter. As you know, severe market volatility and continued economic uncertainty pushed many investors to the sidelines this quarter. In the midst of this uncertainty, our focus remain on prudently managing our business while laying the groundwork for earnings leverage into a recovery. To that point, since we announced our streamlining initiatives 6 quarters ago, we have successfully achieved annual run rate savings of over $100 million. In approximately the same period, we deployed about $1 billion of our excess capital in the form of share repurchases, seed investments and dividends. We've also invested the product innovation that we believe will lead to growth down the road.

In August and September, our affiliates, our wholesalers and marketing teams worked tirelessly with clients to help them understand issues like the U.S. downgrade and the subsequent volatility related to the situation in Europe. Headwinds remain, most notably the debt crisis in Europe persistent unemployment and political gridlock in the U.S. and inflation in the emerging economies. However, the markets have rebounded thus far in October. We believe the U.S. problems are solvable, that today's news in Europe is encouraging, that China can engineer a soft landing and that interest rates will remain low in developed markets for the foreseeable future.

So let's shift to our results on Slide 3. Legg Mason reported net income of $56.7 million or $0.39 per GAAP -- per share on a GAAP basis. Adjusted income per diluted share was $0.61. As a reminder, adjusted income is where we add back certain noncash and other expenses, and exclude the tax rate change.

We ended the quarter with assets of $612 billion, largely driven by $33 billion of market depreciation and negative foreign exchange impact. We realized $26 million in transition-related savings, and we repurchased during the quarter approximately 7.5 million shares.

On Slide 4, our assets are broken out by asset class. We ended the quarter with 24% in equity, 58% in fixed income and 18% in liquidity. The decline in equity assets was largely driven by market depreciation.

Slide 5 shows our net flows for the quarter. Fixed income outflows increased from the prior quarter. These resulted from continuing withdrawals in the low-fee sovereign mandate, portfolio rebalancing among institutional clients and a continued move by some clients to passive mandates. Our equity outflows were flat in the quarter, while the industry experienced a significant increase across most categories. To be fair, our prior quarter included some special situation redemptions. And liquidity outflows were approximately $3 billion driven by a redemption from a client to fund their planned capital expenditures.

Slide 6 shows our assets by affiliate. Broadly speaking, we witnessed the retrenchment across the industry as investors avoided risk, and this impacted all of our investment managers. Each remain close to the markets and their clients as we work through the fallout from S&P downgrade of U.S. debt and the continued uncertainty in Europe.

Let's start with Western at $433 billion. We will discuss Western in more detail in the next slide, but broadly speaking, inflows into specialized mandates were more than offset by outflows from the global sovereign mandate we have referenced for some time, and uptick in outflows in core mandates due to rebalancing and several clients shifting to passive strategies.

Second is Permal at $19 billion. The decline in assets was driven by market depreciation, the conclusion of a relationship with a private bank and a withdrawal by a sovereign client from a third-party product from which Permal was the sub-advisor. They continued to see solid subscriptions from institutional clients, which now make up 40% of their business, and they continue to build relationships with family offices around the world. The firm has over 500 million in unfunded wins in the institutional pipeline. They believe that macro strategy should remain attractive in these markets, which bodes well for the products that they manage. At Legg Mason, we continue to work with them on opportunities to broaden their retail presence.

Next is Royce at $33 billion. The decline in assets was driven primarily by market depreciation. Royce did experience outflows for the quarter though they continue to hold up well compared with competitors in the active small cap universe. Performance remained strong with 85% of their assets rated 4 or 5 star by MorningStar.

ClearBridge is next at $47 billion, with the decline in assets driven by market depreciation and outflows from large cap equity strategies. As I referenced earlier, investors pulled away from U.S. equities in the second quarter, which affected ClearBridge. However, ClearBridge's dividend and income strategies have strong performance, and we believe that they can benefit as these are the products investors are most focused on in the equity space going forward.

Next is Batterymarch at $17 billion, reflecting the significant depreciation in equity markets, and in their case particularly, in emerging markets. A large pension client moved money back in-house, and reflecting broad industry standards, there was an allocation away from core equity.

Brandywine is next at $31 billion, down from the prior quarter primarily due to the foreign exchange impact on fixed-income assets and modest outflows as a result of client rebalancing. Their funding pipeline is the largest since March '09 at $800 million, and RFP activity is also picking up. A key to Brandywine's success has been in the global fixed income space where they have a strong track record outperforming the composite indices for the 1-, 3-, 5- and 10-year periods, which is helping to drive the wins in their pipeline.

Finally, Legg Mason Capital Management ended at approximately $9 billion with a reduction in AUM mostly driven by market depreciation. There was a significant decline in outflows from the prior quarter.

Let's turn to Western on Slide 7. You can see performance in the upper right-hand corner. Western's 3- and 10-year performance numbers remain very strong with over 85% of composite assets beating benchmarks. However, this past quarter was very difficult in fixed income markets with sharp underperformance in risk assets and the Barclays AG outperforming 93% of fixed income managers in Core Plus portfolios. In fact, this was the third worst quarter on record for performance of investment-grade credit versus treasuries with the other 2 being the last 2 quarters of '08. As you can imagine this had a negative impact on Western's 1-year numbers, but they've performed better versus peers in this quarter's market dislocation than in prior periods of stress, and they are emphasizing that point with clients and consultants as we speak.

Likewise, the 5-year numbers reflect the effect of both this most recent market volatility and the second half of '08. Outflows in the quarter partially reflect the impact of the global sovereign mandate we've been referencing for several quarters. Clients are also reviewing some broad marketing allocations like Core, Core Plus in supplementing with strategies for better risk reward in this low-yield, higher-volatility environment. In fact, our results include higher fee wins into specialized strategies like emerging markets, limited duration, investment grade credit and high yield, as well as continued inflows into Australian and Brazilian bond fund.

Growth in both the finals presentations and RFP pipelines also underscore Western's return to playing offense, albeit from a modest space. In the quarter, Western was in finals presentations with $4.3 billion, up approximately 80% from the prior quarter. And Western's RFP pipeline for the quarter represented over $13 billion in assets, a little more than double the previous quarter.

A recent well-known industry survey of investment consultants shows improvement. Two years ago, 21 consultants at Western Asset were on a watch-closely list. Today, only 2 consultants still have us on that on that list. We are pleased by the pipeline growth. Western is well-positioned with their globally diversified product capabilities to take advantage of growth and interest in specialty mandates and global scope. This will allow us to supplement what is likely to be softness in active Core, Core Plus mandates across the industry.

Slide 8 shows our marketed composite performance versus the benchmark. Given our concentration in institutional segment, we believe this is a good representation of our broad base of assets. As you can see, the 10-year and 3-year numbers remain strong, with over 80% of the assets beating their benchmarks. The 1-year and 5-year numbers are more challenged, primarily because those time frames reflect the 3 most difficult time in credit markets which we just discussed.

And Slide 9 shows long-term fund performance against the category average, which underscores the improvement that has been made versus the peer group. We're giving you both views because this shows where we rank against our competitors in the fund space. Here, you can continue to see improvement across most time periods with very strong performance in 3-, 5-, and 10-year timeframes. Importantly, October results in our fund business reflect renewed demand and positive flows for both taxable fixed income and munis, thanks to this performance.

Slide 10 shows a breakdown of our global distribution platform. While our mix is deeper in the U.S., our international business continues to grow impressively. During the quarter, we completed the reorganization of our U.S. team and are now hitting the ground running. We have seen particular interest in funds managed by Western, ClearBridge, Royce and Brandywine.

And now we'll talk about the product progress in U.S., as well as international. In the U.S., our focus remains on diversifying our business beyond our legacy channels, while internationally, it is more of a broad-based growth story.

Slide 11 shows the trends in our U.S. distribution long-term flows. Gross and net sales were down from last quarter, which included the large sub-advisory win and a closed-end fund launch. This quarter reflected a return to slightly positive flows in municipal bonds after several quarters of outflow, and we continue to see good diversification of sales channels. While this market -- quarter did not provide a strong backdrop from which to launch new products, we continue to work with our affiliates on product initiatives that we expect to implement over the next few quarters as markets stabilize.

Slide 12 shows trends in our international distribution platform. This marked their 11th straight quarter of inflows, led by inflows into sector-specific, fixed income mandates in Japan. We continue to work on new product development, launching new funds in our cross-border range and in local markets in which we expect to get traction down the road. We saw increased activities with distribution partners for fixed income and equity separate accounts in Japan.

As part of my regular schedule of visiting with our clients, distribution partners and affiliates around the world, I recently returned from spending a couple of weeks across Asia. With approximately 15% of Legg Mason's assets in Asia, this region continues to be an important growth area for Legg Mason and our affiliates going forward.

On Slide 13, we list the successes we've had in working with our affiliates to launch new products to serve our clients worldwide. As you can see from the list, we've been able to tap into the unique strengths of our affiliates to create innovative products. We've raised nearly $20 billion in assets from these top products alone.

Let me now turn it to Pete.

Peter H. Nachtwey

As Mark indicated, the second quarter had its challenges, but overall, we continue to make progress reducing expenses and more specifically, in streamlining our business model, with the aim of increasing operating margins and net income. We also continue to add value to shareholders by executing our share buyback program. In combination, these efforts are positioning the business for long-term growth in earnings per share.

As I indicated last quarter, fiscal Q2 saw the ramping up of underlying savings related to our streamlining efforts. Prospectively, next quarter's results will reflect our most significant level of transition-related expenses as we fully write-off excess office space. Also at the end of December, our final headcount reductions will take place.

In the current quarter, a number of factors impacted our results. These included significant volatility in both financial markets and foreign exchange rates, as well as a pickup in outflows reflecting investors' increasing concerns about the market. These factors combine the depressed revenues, margins and earnings in the near-term.

Also with the difficult markets, our performance fees came in below recent levels. On a positive note, for the first time, the benefits of our expense reduction efforts have more than offset the costs associated with the streamlining process, and we continue to be deliberate with our capital allocation efforts returning a significant amount of our excess capital to shareholders in the form of buybacks.

Now let's turn to Page 14 to review the financial highlights for the quarter. Fiscal second quarter of 2012 net income was $57 million, which resulted in $0.39 in earnings per diluted share, and that included the impact of $15 million in transition costs and a net $20 million in mark-to-market reductions primarily associated with our over $400 million seed investment portfolio. Together, these reduced our diluted earnings per share by $0.16. We also had an $18 million U.K. tax benefit as mentioned on last quarter's call, and this had a positive impact of $0.13 on our second quarter earnings.

Operating revenues were down 7% compared to the prior quarter due to a decrease in average AUM, a slightly lower advisory fee yield, reflecting a drop in equity assets and a decline in performance fees. The $9.9 million in performance fees earned this quarter were largely driven by our fixed income managers, principally, Western Asset.

Operating expenses were down 9% reflecting lower revenues, the impact of the mark-to-market of deferred comp and seed investments, which are offsetting other nonoperating income and expenses, the benefit of our streamlining initiative and the impact of last quarter’s $11 million in costs related to a closed-end fund launch. I'll go into more detail in expenses a bit later.

The adjusted income, which excludes certain noncash and other items, was $88 million for the quarter or $0.61 per diluted share, which includes the impact of the mark-to-market loss on our seed investments.

Moving onto Slide 15. The only other item to highlight here is our GAAP income tax line, which is providing a net gain as a result of the previously disclosed $18 million benefit resulting from the recently enacted U.K. rate reduction. For the second half of fiscal 2012, we expect our rate to be in the low- to mid-30% range on a GAAP basis.

And I'd also like to highlight, as has been the case in prior periods, our cash taxes will be much lower as our net operating loss carryforwards and foreign tax credits, along with our ability to amortize a significant amount of our intangible assets for tax purposes will generate $1.7 billion cash tax benefit. This will reduce the actual cash taxes paid both this year and prospectively, and will allow us to utilize this cash to create additional value for shareholders.

Turning to Slide 16. You can see that the advisory fee yield declined this quarter from 36 basis points to 35 bps, driven by a significant decline in equity markets in August and September, which drove the equity share of our assets down to 24%. But you can also see that our advisory fee rate is still up from the 34 basis points in September 2010 quarter and 32 basis points in September 2009.

Flipping to Slide 17. Operating expenses for the quarter decreased through the lower comp and benefits associated with reduced revenues, the impact of mark-to-market adjustments on deferred comp and seed investments, the benefit from our streamlining initiatives and the fact that last quarter's results include the cost associated with the closed-end fund launch. Overall, comp and benefits declined 13%, which I'll address in more detail in the next slide.

Distribution and servicing costs were lower as last quarter's results included payments to third parties for the close-end fund launch, while the remainder of the drop is the result of our lower assets and revenues. Occupancy expense increased as a result of a lease loss reserve adjustment. And finally, the increase in other expenses include several items we've previewed last quarter. This included $3 million in annual costs associated with advertising, new corporate governance, as well as some expenses at our affiliates where there was an offset in comp and benefits.

So in aggregate, our corporate expenses, excluding our streamlining-related savings, increased approximately $8 million quarter-over-quarter. In addition to the $3 million that I just referenced under other expenses, there was the final $2 million related to the Western reimbursement step down, which we've discussed in prior quarters, along with $3 million of one-off expenses, including foreign exchange fluctuations and the lease loss reserve adjustment that I highlighted under occupancy.

GAAP basis comp and benefits, highlighted on Slide 18, were down again nearly 13% from last quarter, reflecting all the same drivers I've mentioned previously. One additional thing I'd like to highlight here, though, is the impact of mark-to-market on deferred comp and seed investments, which is $14.2 million in the quarter compared with only $2.4 million in fiscal Q1. Excluding the deferred comp and seed investment offset and the transition-related cost, the comp and benefit to net revenue ratio was 53%. That comp ratio is about 1 point lower than expected this quarter due to the several expense items that revenue share affiliates which were offset in compensation. We expect the comp to net revenue ratio to be in the 53% to 54% range once the streamlining is complete. And as we grow revenues in the future, we anticipate that the trend -- the comp ratio will trend downward slightly as we hold the line on corporate expenses.

Turning to Slide 19. The operating margin, as adjusted, came in slightly better than last quarter's results, again in part, due to last quarter having costs associated with the closed-end fund launch. Excluding that impact, our operating margin as adjusted would've been 1.7% higher than the prior quarter. And the decline against that higher result was driven by lower you AUM and lower performance fees, which more than offset the benefit from our streamlining initiative.

Turning to Slide 20. We are now in the homestretch with just a few more months to go before we complete our streamlining initiative. In the quarter, our savings came in at $26 million or $104 million on an annualized basis. As I highlighted on last quarter's call, June 30 was a major milestone in our streamlining initiatives as we completed the migration of systems and functions to affiliates as planned. To date, we transitioned 300 employees or the 20% of our March 2010 staffing levels, with an additional 125 transitions planned for December 31, 2011.

In the quarter, we incurred $15 million in transition-related costs, and we expect to incur approximately $45 million next quarter bringing the total streamlining cost to approximately $130 million. The level of next quarter's cost savings will remain at approximately $26 million as the final round of headcount reductions is not scheduled to occur until December 31. In our fiscal fourth quarter, we anticipate achieving $35 million in savings or approximately $140 million in annualized savings.

Speaking of the fiscal fourth quarter, I would like to provide you with an update on our outlook. And again, we normally do not give guidance, but we recognize that this is a key turnaround year for us, and we thought it would important to give you some directional guidance on the fourth quarter. With a significant market decline in the September quarter and reflecting the economic reality of lower Assets Under Management, we're now projecting fiscal Q4 EPS of $0.42 to $0.52 per share, which is in line with analyst estimates and reflects moderate market appreciation and a reduction in expected performance fee levels.

Now let's turn to slide 21. Here you can see we repurchased $200 million worth of shares this quarter and have now repurchased 28.2 million shares or 17% of our outstanding shares as of March 31, 2010. This brings our ending share count as of September 30 to just under 140 million shares, and we still have 155 million remaining on the original board repurchase authorization of $1 billion. On the dividend front, the board declared a quarterly dividend of $0.08 per share unchanged in the prior quarter but up from $0.04 per share in September 2010 quarter.

One of the other areas I wanted to highlight this quarter is our seed investments. Of our $421 million seed investments as of September 30, 57% are invested in alternative and equity strategies, and 43% are invested in fixed and liquidity strategies. We allocate capital to seed new products on an opportunistic basis when we believe we have a marketable strategy and a perform advantage.

Due to the recent market turbulence, the mark-to-market on this portfolio resulted in approximately $20 million in unrealized losses in fiscal Q2 compared to unrealized gains in the prior quarter. The fact that GAAP requires us to mark these investments to market each quarter creates volatility in our short-term results. But it is important to note these losses are unrealized and our strong balance sheet and liquidity gives us the ability to hold these investments until our strategic objectives have been achieved.

We believe seed is a driver of future organic growth. To that end, we believe the key measure of seed capital is the AUM raised in the underlying products. We presently have $26 billion of third-party assets in currently seeded proprietary products. Total AUM and seed products will ebb and flow over time as investments are redeployed into new seed products and as a result of investment returns.

Let me turn it back to mark to wrap up with some closing remarks.

Mark Raymond Fetting

Thanks, Pete. Slide 22 shows our 3 strategic drivers for value creation at Legg Mason: first, outstanding independent investment managers; second, continued discipline on a corporate center that delivers strategic value; and third, a balanced portfolio across asset classes, geographies and channels.

On Slide 23, I ask you to step back and look at the bigger picture and in particular, the progress we've made with regard to positioning the company for longer term earnings leverage. In our opinion, it all starts with our ability to generate cash, which has held up very well during this period of market turmoil. The chart at the top left highlights that our operating income, as adjusted, has also held up well and has been relatively consistent despite the decline in AUM. Although the past isn't proxy for the future, we're encouraged by this comparison, because it suggests that even in choppy and volatile markets, the Legg Mason affiliate model is capable of delivering financial performance that give us the flexibility to create long-term value for our shareholders.

As the capital allocation chart shows, over the last 6 quarters, we have returned about $900 million to shareholders in the form of share repurchases and dividends. We've also made seed investments of approximately $100 million. We consider these seed investments to be important drivers of future organic growth. Additionally, over the last 4 quarters, we've generated annualized cost savings of more than $100 million with more to come in Q4 as Pete outlined in his remarks.

Finally, we're focused on performance and client service. And we're moving in the right direction in terms of the critical 3-year time period. History tells us that ultimately, flows will follow that performance, so we understand how critical it is to maintain this trend line. Taken together, these graphs demonstrate that even though positive flows and asset growth are essential to our turnaround's success, they are not the only determinant. In fact, we believe that if we continue to generate consistent levels of adjusting -- adjusted operating income, deliver on expenses and buybacks and make investments in organic growth that we're positioning the company to do very well on the bottom line during this transition phase.

We will continue to benefit from the evolution of our model to deliver earnings value over the near-term while aggressively pursuing flow improvement and asset for long-term success. We're excited to be executing on these goals.

And with that, we'll open the line for questions, and thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Dan Fannon of Jefferies.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

Pete, maybe if we could just start with the guidance and -- is that based on September 30 AUM levels or does that include what's happened thus far in October?

Peter H. Nachtwey

Basically, Dan, it includes some moderate projection from where we were about the middle of October through the end of March.

Daniel Thomas Fannon - Jefferies & Company, Inc., Research Division

Okay. And then as we think about the fixed income business at Western, you guys gave some nice color around RFP activity and I was wondering if you could talk about redemption rates and kind of what's happening if there has -- if that has slowed down as the quarters progress? Or as you to think about, maybe any year-end impact that might happen from withdrawals from their unit?

Mark Raymond Fetting

Well, Dan, on the redemption rates in the retail space, which is an important, a very important category for Western globally both in the U.S. and international, I would say certainly through October, redemption rates have trailed down. And probably even more importantly, sales -- gross sales coming in have picked up. As it relates to the institutional side and the kind of seasonality, you see sometimes in either the fourth calendar quarter or even plus or minus into the first, I don't think we would expect anything unusual in that, that there may be some, but we're not seen anything specific to Western that would be distinctive.

Operator

Our next question is coming from Roger Freeman from Barclays Capital.

Roger A. Freeman - Barclays Capital, Research Division

Just a follow-up on Western. You see the sovereign mandate that have been coming out, is that still at plus or minus $1 billion a month? And also, the win rate, the finals you were talking about having picked up a lot, maybe over the past couple of quarters what have your win rates looked like?

Mark Raymond Fetting

Well, in terms of the global sovereign mandates, it's about the same level, Roger, about -- it picked a little bit in the quarter, but roughly that $1 billion a month or so is good. Relative to the win rate, this is very encouraging between kind of that consultant support that I've cited, and the kind of the fact is we're getting into more finals. So as I said last quarter, when -- we're getting to this kind of in many areas approaching the 30% range, which is a normalized win rate. And we're looking forward to get back to that high watermark of well above that 50%. We're not there yet, but we are making good progress on the win rate.

Roger A. Freeman - Barclays Capital, Research Division

Okay. And then just a follow-up on -- in terms of international opportunities, how do you -- how are you looking at this environment right now? There's been a lot of talk, obviously, about properties potentially available, but Invesco was saying, on their call that, a lot of what they've looked at is kind of got a higher risk profile and the like, and I was just curious with your international growth plans how this landscape is backed up?

Mark Raymond Fetting

Well, on the international, we're very encouraged by what we have on the ground in terms of product and distribution momentum. We'll continue to look down the road on filling holes in kind of a potentially lift-outs, et cetera. But in the near-term, we're focused on organically growing. We've got good momentum there.

Operator

Our next question is coming from Michael Carrier of Deutsche Bank.

Michael Carrier - Deutsche Bank AG, Research Division

And maybe just 2 questions on the outlook. When we think about the fourth quarter given that guidance range in terms of EPS, in terms of margins, where do you think you can get to in the fourth quarter? And then longer term, what drives that higher? And I think when you first announced the streamlining, that expectation is maybe longer term you could get up to like the upper 20s, 30% range. And then just on the cash and buybacks, if you're nearing the kind of the buyback authorization, still generating a lot of cash flow, had the deferred tax benefit on the asset side, what's the outlook there as we -- you go through the next 12, 18 months?

Mark Raymond Fetting

Yes, Michael, thanks, good questions. On the margin front, so as the last slide that Mark talked about showed, we got a big uptick in terms of the realized savings that we had in the last quarter. And that actually bought us around 300 basis points in terms of additional margin, although that gets hidden by the fact that the markets dropped significantly. On a go-forward basis, kind of looking about another 200 bps or so when we get into the fourth quarter with the remaining headcount reductions. And then things that would drive that beyond there, just obviously, our revenues getting back -- went to hopefully rebounding markets. Our revenues getting back, and then we're keeping a very tight lid on headcount at this point. We think we got a very leverageable model going forward. The other thing that would -- that happened in this quarter, I emphasize my remarks, but just to make sure you picked up on that, there were about $8 million of one-off expenses during this current quarter. On the buyback front, we're very strong in our cash position. We've got $155 million remaining on the buyback, and we're looking at deploying that as of next year currently. But we talk to the board all the time, Mark and I are looking at capital priorities on a regular basis, consulting with the rating agencies and what we need from our capital planning.

Michael Carrier - Deutsche Bank AG, Research Division

Okay. And then, Mark, maybe just on the fixed income side at Western, when you look at where the allocations are going, given to maybe more than this year, there'd be better -- higher-yield in the credit products, when you look at their portfolio of offerings, is it where Western wants it to be? Are there still more investments to be made in terms of launching your new products or bringing on some teams? Just trying to gauge given where the allocations are going in institutional front.

Peter H. Nachtwey

I think that's the importance of Slide 7, which shows the asset broken out by mandate, whereby 46% of their current assets are in this specialized category, and they are winning business at a nice rate across the spectrum of corporate emerging markets, long-duration, global inflation link, et cetera. So what we see going forward is Western really culminating with their long-term strategy of going beyond its core legacy strengths in credit and Core, Core Plus but into a broad, global solutions provider to fixed income clients around the world. And so we believe what Western is going to continue to do is kind of gain momentum on the specialized front and their adds to staff in their key offices of London, Singapore, Australia, Brazil in addition to Pasadena and New York have been very helpful in continuing this momentum. Finally, on the Core, Core Plus while we see the softening and others have referred to it this week in kind of industry releases from other firms, it's still going to be there, it's just a softer source of new business than it's been in the past.

Operator

[Operator Instructions] Our next question is coming from Bill Katz of Citigroup.

Neil Stratton - Buckingham

This is actually Neil filling in for Bill. Coming back to the capital management discussion, I was wondering if you could just put in rank order how you see the progress from there?

Mark Raymond Fetting

Well, the capital management as you could see as I kind of concluded on the final chart has been a very important part of our strategy, and we would expect to continue that. The priorities will remain, first and foremost, make sure we have the capital to protect and grow the business. Two, look to grow organically where it makes sense, and then assuming we continue to generate the cash we have to deploy that excess capital for the benefit of shareholders in buybacks and kind of a dividend level that we've been talking about, really, we've kind of targeted the 20% payouts, so that will be an element, but we think that 20% payout is appropriate for our kind of firm.

Neil Stratton - Buckingham

Okay. And then as a follow-up, given the more difficult backdrop, is there any opportunity for more saves beyond the ones identified?

Mark Raymond Fetting

I think in this backdrop, you're quite right to reference, all of us in the industry have to stay vigilant. So our near-term commitment is to very much deliver on the March 12 quarter. But we'll continue to look at the issues of effectiveness and efficiency and take advantage of that. In regard to that, if you just take a look at our headcount reduction, while we've done -- as Pete said, 300 people tied to our streamlining efforts, we've also reduced headcount beyond that in terms of just not filling positions in this environment.

Peter H. Nachtwey

And I have one thing to that, Neil, our biggest expense by far is compensation. And our revenue share model kind of just automatically adjust that. So when our revenues go down, compensation of the affiliates kind of automatically goes down. So there's a bit of a self-regulating device there.

Operator

Our next question is coming from Michael Kim of Sandler O'Neill.

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

Just a follow-up on Western, can you maybe help us kind of get our arms around the level of some of these kind of rebalancing outflows or kind of a shifts to passive mandates that hit this quarter, just so we can get a better sense of that?

Mark Raymond Fetting

Yes, I think here again, you probably picked up this theme from other managers reporting over the last 2 weeks. The rebalancing is what you see in severe market moments where institutional clients by policy requirement have to rebalance into equities to maintain a position, and it's a bit counterintuitive, obviously, in terms of what the kind of equity performance would suggest. Nonetheless, it's done to adhere to policy requirements. We saw that most clearly in September, and it's eased up as you would expect because of what's happened. The S&P is up 7% since quarter end, Russell is up 10%. The Dow is up 10%. But that is encouraging vis-à-vis Western. On the passive piece, we're not seeing any more or less, but just a continued couple of clients moving to passive. And I don't expect that changes much, although if we get into a more sustained less volatile environment, I think clients will appreciate the value that comes from active strategies, and that gives us an opportunity.

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

Okay. And then just kind of maybe coming back to the streamlining, I know you reaffirmed kind of the high-level timeline of the initiatives, but just maybe taking the other side, just given kind of the market volatility, have there been any kind of issues or delays that may have cropped up in terms of transitioning some of the costs over to the affiliates?

Mark Raymond Fetting

No, in fact, I'm very proud of our colleagues, my colleagues both at the affiliates and in the corporate team. In that because this has been, I think, essentially 18 months well thought-out plan, rigorously put together and implemented, we've not seen any of those issues. It's not to say, as I've said all along, it's not been without some pain. Obviously, for a firm like us to have this kind of headcount reduction is disappointing, but it's absolutely the right thing to do. Everybody is committed to it. And really what we look forward to see is it's behind us at the end of the calendar year, and we can focus on growing the business.

Operator

Our next question is coming from Glenn Schorr of the Nomura.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

I'm just looking to get a little more color on the flows, you had mentioned, one is rebalancing and one's in-sourcing, just curious on how chunky that was, and how prevalent that is as a theme, and then I'll ask on the inflow side.

Mark Raymond Fetting

Well, in the sense that flows picked up in the quarter-over-quarter, those going out on the rebalancing were in the couple of billion category, across a couple of key clients. And those in the passive were a little bit less, and there, again, kind of driven by maybe 1 or 2 clients. Here again, what that kind of clouds a little bit is the business coming in on the other side of a ledger in the specialized areas, and that was very strong and diversified.

Peter H. Nachtwey

Glenn, also important to remember that someone asked earlier, the global sovereign mandate continue to go out a little over $1 billion a month, so there is a $3.5 billion in the quarter related to that very low fee mandate and their flows.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

Right. I appreciate. And then more on the rebalancing, is that simply a function of equity markets got select and people just doing it on a more timely basis than in the past?

Mark Raymond Fetting

Yes, it's exactly it, and it's very formulaic. It's just something clients have to do, and in Western's case, because they're an active manager in this environment given this kind of shift from Core, Core Plus, they're a little more of a target in that September period, and we think it will be going forward. Going back to your question around kind of going in-house, that actually -- related to one client at Batterymarch, which was therefore an equity mandate.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

Got it. And then on the positive side of the ledger, so the June quarter included large sub-advisory win when you were talking about the U.S. distribution in the quarter, end of quarter. What are you seeing on the sub-advisory front. I'm sorry if I missed it in the pipeline commentary, but is there still a force on the RFP side for the sub-advisory mandates?

Mark Raymond Fetting

Yes, in the near-term what we see on the sub-advisory side is more of the just kind of existing model portfolios kind of having flowed in and out, just to the portfolio rebalancing. The longer term, I think, like other institutional clients, I think they're going to wait and see, as we come out of this market volatility, and certainly today's news are encouraging. And then we think we've got a good array of options to be considered for new mandates, but that will be kind of more down the road.

Operator

Our next question is coming from of Cynthia Mayer of Bank of America.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Can you update us a little more on Permal? What do you think is behind the outflows and how's their performance versus the other large fund -- the hedge fund managers? And also your $10 million to $15 million performance fees for the December quarter, does that include any assumption for Permal?

Mark Raymond Fetting

Yes. Let me take the first part and then Pete will take the performance fee question, Cynthia. In terms of Permal really on a relative basis to peer group, they continue to fare very well. In fact, there's a recent publication that list them among the top, if not the top, grower in the institutional space for a funded hedge fund manager. The issue this quarter, which we previously had talked about was the kind of conclusion of a private bank relationship, and then the separate issue around a kind of redemption in a product where for a sovereign client, they are a sub-advisor to somebody else's platform. If you take those 2 things out, Permal is actually faring relatively well in the space. Clearly, the space -- it was unfortunate in terms of demand, because what we were seeing before the September volatility was the high net worth traditional family office investors starting to come back in. That's kind of been put to a halt right now, so the growth that you see is more on this institutional side, which is very good. But once that high net worth investor comes back in the macro strategy, we think is a very good one, Permal should do quite well, and these 2 special situations are now behind us.

Peter H. Nachtwey

And, Cynthia, on the performance fees, from Permal's standpoint, keep in mind they are mixture of both equity and fixed income products in their portfolios, so they were down a bit in this current quarter. We expect that to recover in the fourth quarter, but not quite to the normal levels for them.

Cynthia Mayer - BofA Merrill Lynch, Research Division

Okay. And I guess, just as a follow-up, if they lost the private bank relationship, how much did that contribute in the past in terms of quarter-to-quarter flows and -- so would missing that somehow impact the future flows?

Mark Raymond Fetting

In terms of flows, it was not a significant -- that some of those assets were kind of historic, really dating back to 5-plus years, so it's never good, obviously, to have that kind of conclusion, but it's one we are past and getting very good support from other both existing distribution partners, and in fact, new ones. They have come in and particularly in Europe and Asia. Here again, that had no bearing on the growth in the institutional side, which they continue to do quite well with. And as we said, they got $500 million of funded pipeline. Some of that is public fund business, and that takes a little longer, so it's not like all the $500 million goes into the coffers this quarter, but it's a scored win, and we're going to get that money.

Operator

[Operator Instructions] Our next questioner is coming from Mac Sykes of Gabelli & Company.

Macrae Sykes - Gabelli & Company, Inc.

My question is about Western's contribution. When you add in their share of corporate expenses, would you characterize the profitability of the affiliate as being additive to the margin of the total complex and significantly so?

Mark Raymond Fetting

Certainly additive and both from a margin contribution and obviously, from a -- in a flow standpoint, the sooner we can move into a more consistent positive flow contributor to, I think, the valuation of the firm.

Macrae Sykes - Gabelli & Company, Inc.

Okay. And then just one follow-up. Would it be possible in the future to combine some of the smaller equity affiliates' consolidated shared services and technology, sort of take the best-of-breed products, maybe, I guess sort of internal M&A? What combinations could you envision on that?

Mark Raymond Fetting

Well, as we said in the past, we are always looking to optimize the portfolio. And particularly in the smaller areas, we've done both some kind of deletions, consolidations, and we'll continue to be proactive on that where it makes sense but truly on a facts-and-circumstance basis.

Operator

Our next question is coming from Marc Irizarry of Goldman Sachs.

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

Just a couple of quick follow-ups on Permal. How much of the AUM is quarterly versus annual locks? And then -- I don't know if you've -- gave us and I missed it, but any insight in terms of -- you mentioned, I think, the subscriptions but what about the redemptions, the redemption notices for the year end for them?

Peter H. Nachtwey

Yes. I don't have the exact number in terms of quarterly versus annual for this past -- or I would just -- I know that most of them for this past quarter were quarterly. Obviously, December quarter is the one when we have the majority of our annual locks.

Mark Raymond Fetting

And on the -- Marc, on the redemption notices, we -- here again, we're not seeing anything disproportionate as we approach year end.

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

Okay. And then, I guess, you mentioned that the gross descriptions are still sort of tracking around in-line or...

Mark Raymond Fetting

Yes. The institutional opportunities continue to move well and then too soon to tell coming off of this, I'd like to see another month in terms of the sales into this, the core high net worth side. You would expect that to pick up a bit, although still tempered, too soon to kind of see a trend there.

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

Great. And then, Mark, just the -- you mentioned the $500,000 to $1 million unfunded to mandate. And if you just look across sort of the -- with the world of your affiliates and the institutional activity, are you -- I think we've heard a lot of managers characterize activity as frozen. Where are we in the process, maybe, of the thawing and maybe some these pipeline -- some of the pipeline being funded? And how do you sort of characterize the pipeline for Western in particular?

Mark Raymond Fetting

This is actually a real area of encouragement for me because I think, yes, that clearly, if you come off a quarter like the September quarter with the severe volatility we saw, it puts a cloud on things, and as an industry backdrop, that's true. On the other hand, at the micro level of our firms whether it's Brandywine with $800 million of funded opportunities there, clearly, Western, and we acknowledge from a lower base because their performance improvement needed to be consistent, you are seeing some quarter-over-quarter and year-over-year encouragement in terms of new business opportunities, and then even in Permal, the institutional side. So I would say actually, macro, yes, and then in addition, things that might hit us more directly, the kind of the softening of demand around for Core, Core Plus and fixed income, as I've said for several quarters now, kind of pushes out a category that would normally, with the improved performance, kind of be delivering more near-term. But that's something we just have to play through as the whole industry does. But micro, I'm encouraged. So I can affirm the macro, but I'm encouraged on the micro as it relates to our business portfolio.

Operator

Our final question is coming from Jeff Hopson of Stifel, Nicolaus.

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

I guess, hedge funds didn't for form so well here in September. Can you give us an update on Permal's overall performance?

Mark Raymond Fetting

Yes, their flagship strategies have outperformed their peer group consistently, including September and appear to be doing the same in October. I think in terms of going back to this macro theme, the near-term impact is kind of a -- puts a bit of a timeout on the return of the high net worth investor, but it continues to have good demand on the institutional side and performance as part of it.

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

Okay. So if you looked at, I guess, their assets were down about 11%. How much of that would have been kind of just gross performance versus the outflows? Any way you can help us on that.

Mark Raymond Fetting

Here again, I'll start with the -- in terms of the flows, a good chunk of that, the outflows came from these 2 situations. But if you were to take the total change in AUM, roughly, half is market and half is closed.

Okay, I think that was the final question on behalf of Legg Mason, we want to thank you, and we look forward to continuing to report on our results against the good goals that we have. Thank you 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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