Stock Analysis Pic B

Legg Mason: A Deeper Look at the Performance

Stock Analysis Pic B

For more than a century, Legg Mason has been a leading player in the world of active funds management. Founded in Baltimore in 1899, the venerable asset manager (NYSE: LM) employees 3,000-plus workers across six continents and manages more than $700 billion in assets.1

Legg Mason has grown by taking a multi-manager business model. The asset-management arm of its operations consists of nine subsidiary firms that specialize in different asset classes and investment strategies. Those include funds that blend hedging techniques with other alternative active mandates. Subsidiaries acquired over the years by Legg Mason include Brandywine Global, Clarion Partners, ClearBridge Investments, QS Investors, Western Asset Management and Royce & Associates. 

Like many active fund managers, however, investment flow into Legg Mason's equities lineup in recent years has come under pressure from a growing number of investors moving into passively managed funds. In fact, industry analysts credited such a swing in market sentiment to a deal struck in early 2020 by the industry giant to be acquired by another big rival, Franklin Templeton (NYSE: BEN). Since late 2016, Franklin Templeton alone has lost almost $93 billion in net assets, reports trade magazine Pensions & Investments.2  

Nevertheless, the merger stood at the time of its announcement as creating a combined firm with some $1.5 trillion in assets under management.The deal, which still must be approved by government regulators, is expected to close by year's end. 

On the heels of such a mega-merger, however, Legg Mason's adjusted operating margins over the past several years have been falling well-below industry averages, according to Morningstar. In reviewing the deal, analyst Greggory Warren pointed out that his colleagues at the independent research shop have generally been "big proponents" of consolidation by active managers. At the same time, a combo of Legg Mason and Franklin Templeton "was not even on our radar," he added. 

The acquisition sets up a funds complex even more heavily skewed to fixed-income, Warren noted. A merger is "more about gaining scale" than "product gap filling," he observed. Given both firms' history of spurring growth through acquisition, his surprise came out of a general consensus among analysts that Legg Mason was a prime candidate to improve its market position through acquisition of "smaller asset managers." 

When compared to active competitors in similar asset classes and strategies, Morningstar finds that Legg Mason's family of stock funds has produced less-than-stellar results. "From a performance perspective," Warren wrote in a research piece, "Legg Mason's active equity operations have been poorer than they should be, keeping this platform in net outflow mode for much of the past several years." 4

Given such uncertainities, we thought it'd be worthwhile to put under our research microscope Legg Mason as a standalone mutual funds provider. This should help to provide investors with a better view of how the acquisition target's longer-term performance stacked up heading into such a major proposed consolidation in active management.

This analysis is part of our ongoing Deeper Look series, which also includes an analysis of Franklin Templeton post-acquisition news and before any merging of its funds with Legg Mason's smorgasbord. 

Controlling for Survivorship Bias

It's important for investors to understand the idea of survivorship bias. While there are 64 active mutual funds with five or more years of performance-related data currently offered by Legg Mason, it doesn't necessarily mean these are the only strategies this company has ever managed. In fact, there are 113 mutual funds that no longer exist. This can be for a variety of reasons including poor performance or the fact that they were merged with another fund. We will show what their aggregate performance looks like shortly.  

Fees & Expenses

Let's first examine the costs associated with Legg Mason's surviving 64 strategies. It should go without saying that if investors are paying a premium for investment "expertise," then they should be receiving above average results consistently over time. The alternative would be to simply accept a market's return, less a significantly lower fee, via an index fund.

The costs we examine include expense ratios, sales loads -- front-end (A), back-end (B) and level (C) -- as well as 12b-1 marketing fees. These are considered the "hard" costs that investors incur. Prospectuses, however, do not reflect the trading costs associated with mutual funds.

Commissions and market impact costs are real expenses associated with implementing a particular investment strategy and can vary depending on the frequency and size of the trades executed by portfolio managers.

We can estimate the costs associated with an investment strategy by looking at its annual turnover ratio. For example, a turnover ratio of 100% means that the portfolio manager turns over the entire portfolio in one year. This is considered an active approach and investors holding these funds in taxable accounts will likely incur a higher exposure to tax liabilities, such as short- and long-term capital gains distributions, than those incurred by passively managed funds.

The table below details the hard costs as well as the turnover ratio for all 64 surviving active funds offered by Legg Mason that have at least five years of complete performance history. You can search this page for a symbol or name by using Control F in Windows or Command F on a Mac. Then click the link to see the Alpha Chart. Also, remember that this is what is considered an in-sample test; the next level of analysis is to do an out-of-sample test (for more information see here).

Fund Name Ticker Turnover Ratio % Prospectus Net Expense Ratio 12b-1 Fee Deferred Load Max Front Load Global Category
ClearBridge Mid Cap A SBMAX 20 1.18 0.25   5.75 US Equity Mid Cap
ClearBridge Mid Cap Growth I LBGIX 22 0.85       US Equity Mid Cap
ClearBridge Select I LBFIX 21 1.18       US Equity Mid Cap
ClearBridge Small Cap Value A SBVAX 88 1.36 0.25   5.75 US Equity Small Cap
ClearBridge Small Cap C LMASX 38 1.94 1.00 1.00   US Equity Small Cap
QS US Small Capitalization Equity I LMSIX 51 1.00       US Equity Small Cap
ClearBridge Small Cap Growth A SASMX 18 1.20 0.25   5.75 US Equity Small Cap
ClearBridge All Cap Value A SHFVX 14 1.16 0.25   5.75 US Equity Large Cap Value
BrandywineGLOBAL Dyn US Large Cap Val IS LMBGX 126 0.65       US Equity Large Cap Value
ClearBridge Tactical Dividend Income A CFLGX 25 1.64 0.25   5.75 US Equity Large Cap Value
ClearBridge Large Cap Value I SAIFX 14 0.60       US Equity Large Cap Value
BrandywineGLOBAL Div US Large Value IS LBISX 51 0.71       US Equity Large Cap Value
QS US Large Cap Equity IS LMISX 54 0.70       US Equity Large Cap Blend
ClearBridge Value C LMVTX 29 1.75 0.95 0.95   US Equity Large Cap Blend
ClearBridge Dividend Strategy A SOPAX 14 1.06 0.25   5.75 US Equity Large Cap Blend
ClearBridge Appreciation A SHAPX 10 0.95 0.25   5.75 US Equity Large Cap Blend
ClearBridge Aggressive Growth A SHRAX 2 1.12 0.25   5.75 US Equity Large Cap Growth
ClearBridge Large Cap Growth A SBLGX 25 1.03 0.25   5.75 US Equity Large Cap Growth
QS Conservative Growth A SBBAX 25 1.17 0.25   5.75 Moderate Allocation
QS Defensive Growth A SBCPX 19 1.21 0.25   4.25 Cautious Allocation
QS Strategic Real Return I LRRIX 44 1.10       Moderate Allocation
QS Moderate Growth A SCGRX 24 1.23 0.25   5.75 Aggressive Allocation
QS Growth A SCHAX 25 1.28 0.25   5.75 Aggressive Allocation
ClearBridge International Sm Cap I LCOIX 37 1.09       Global Equity Mid/Small Cap
QS Global Equity A CFIPX 52 1.30 0.25   5.75 Global Equity Large Cap
QS Global Dividend IS LDIFX 30 0.74       Global Equity Large Cap
ClearBridge International Value A SBIEX 40 1.26 0.25   5.75 Global Equity Large Cap
QS International Equity C LMGEX 50 2.03 1.00 1.00   Global Equity Large Cap
ClearBridge International Growth C LMGTX 20 1.84 1.00 1.00   Global Equity Large Cap
Western Asset Emerging Markets Dbt I SEMDX 33 0.80       Emerging Markets Fixed Income
BrandywineGLOBAL Alternative Credit A LMAPX 184 1.66 0.25   4.25 Long/Short Credit
Western Asset Macro Opportunities IS LAOSX 165 1.21       Fixed Income Miscellaneous
BrandywineGLOBAL Global Unconst Bond I LROIX 44 0.85       Fixed Income Miscellaneous
Western Asset Total Return Uncons I WAARX 49 0.73       Fixed Income Miscellaneous
Western Asset SMASh Series EC LMECX 37 0.00       US Fixed Income
Western Asset High Yield I WAHYX 71 0.76       US Fixed Income
Western Asset Short Duration High Inc A SHIAX 73 1.00 0.25   2.25 US Fixed Income
BrandywineGLOBAL Global High Yield IS LMZIX 104 0.76       Global Fixed Income
Western Asset Global High Yield Bd I SHYOX 70 0.90       Global Fixed Income
Western Asset Mortgage Total Ret A SGVAX 74 0.96 0.25   4.25 US Fixed Income
Western Asset Income A SDSAX 54 1.00 0.25   4.25 US Fixed Income
Western Asset SMASh Series M LMSMX 268 0.00       US Fixed Income
Western Asset Core Plus Bond I WACPX 122 0.45       US Fixed Income
Western Asset Inflation Idxd Plus Bd I WAIIX 60 0.38       US Fixed Income
Western Asset Short-Term Bond A SBSTX 41 0.75 0.25   2.25 US Fixed Income
Western Asset SMASh Series C LMLCX 23 0.00       US Fixed Income
Western Asset Corporate Bond A SIGAX 84 0.95 0.25   4.25 US Fixed Income
Western Asset Core Bond I WATFX 125 0.45       US Fixed Income
Western Asset Intermediate Bond I WATIX 94 0.54       US Fixed Income
Western Asset Oregon Municipals A SHORX 17 0.75 0.15   4.25 US Municipal Fixed Income
Western Asset Managed Municipals A SHMMX 23 0.65 0.15   4.25 US Municipal Fixed Income
Western Asset New York Municipals A SBNYX 17 0.76 0.15   4.25 US Municipal Fixed Income
Western Asset Interm Maturity NY Muni A IMNYX 31 0.75 0.15   2.25 US Municipal Fixed Income
Western Asset Interm Maturity CA Muni A ITCAX 33 0.75 0.15   2.25 US Municipal Fixed Income
Western Asset California Municipals A SHRCX 20 0.79 0.15   4.25 US Municipal Fixed Income
Western Asset Short Duration Muni Inc A SHDAX 40 0.55 0.15   2.25 US Municipal Fixed Income
Western Asset Pennsylvania Municipals A SBPAX 14 0.78 0.15   4.25 US Municipal Fixed Income
Western Asset New Jersey Municipals A SHNJX 13 0.83 0.15   4.25 US Municipal Fixed Income
Western Asset Massachusetts Muni A SLMMX 15 0.75 0.15   4.25 US Municipal Fixed Income
Western Asset Intermediate-Term Muni A SBLTX 22 0.61 0.15   2.25 US Municipal Fixed Income
Western Asset Adjustable Rate Income C1 ARMGX 32 1.31 0.75     US Fixed Income
BrandywineGLOBAL Intl Opp Bond IS LMOTX 90 0.66       Global Fixed Income
BrandywineGLOBAL Global Opp Bond IS GOBSX 103 0.59       Global Fixed Income
Western Asset Municipal High Income A STXAX 17 0.83 0.15   4.25 US Municipal Fixed Income

Please read the prospectus carefully to review the investment objectives, risks, charges and expenses of the mutual funds before investing. Legg Mason prospectuses are available at:  https://www.leggmason.com/en-us/products/mutual-funds.html


On average, an investor who utilized a surviving active equity mutual fund strategy from Legg Mason experienced a 1.18% expense ratio. Similarly, an investor who utilized a surviving active bond strategy from the company experienced a 0.70% expense ratio.

These expenses can have a substantial impact on an investor's overall accumulated wealth if they are not backed by superior performance. The average turnover ratios for surviving active equity and bond strategies from Legg Mason were 35.46% and 61.12%, respectively. This implies an average holding period of 19.63 to 33.84 months.

In contrast, most index funds have very long holding periods -- decades, in fact, thus deafening themselves to the random noise that accompanies short-term market movements, and focusing instead on the long-term. Again, turnover is a cost that is not itemized to the investor but is definitely embedded in the overall performance.

Performance Analysis

The next question we address is whether investors can expect superior performance in exchange for the higher costs associated with Legg Mason's implementation of active management. We compare all of its 177 strategies, which includes both current funds and funds no longer in existence, against its Morningstar assigned benchmark to see just how well each has delivered on their perceived value proposition.

We have included alpha charts for each of their current strategies at the bottom of this article. Here is what we found:

  • 85.31% (151 of 177 funds) have underperformed their respective benchmarks or did not survive the period since inception.

  • 14.69% (26 of 177 funds) have outperformed their respective benchmarks since inception, having delivered a POSITIVE alpha.

Here's the real kicker, however:

  • None (0 of 177 funds) wound up outperforming their respective benchmarks consistently enough since inception to provide 97.5% confidence that such outperformance would persist (as opposed to being based on random outcomes).

As a result, this study shows that a majority of funds offered by Legg Mason have not outperformed their Morningstar-assigned benchmark. The inclusion of the statistical significance of alpha is key to this exercise, as it indicates which outcomes are due to a skill that is likely to repeat and those that are more likely due to a random-chance outcome.

Regression Analysis

How we define or choose a benchmark is extremely important. If we relied solely on commercial indexes assigned by Morningstar, then we may form a false conclusion that Legg Mason has the "secret sauce" as active managers.

Since Morningstar is limited in terms of trying to fit the best commercial benchmark with each fund in existence, there is of course going to be some error in terms of matching up proper characteristics such as average market capitalization or average price-to-earnings ratio.

A better way of controlling these possible discrepancies is to run multiple regressions where we account for the known dimensions (betas) of expected return in the U.S. (i.e., market, size, relative price, etc.).

For example, if we were to look at all of the U.S.-based strategies from Legg Mason that've been around for the past 10 years, we could run multiple regressions to see what each fund's alpha looks like once we control for the multiple betas that are being systematically priced into the overall market.

The chart below displays the average alpha and standard deviation of that alpha for the past 10 years through 2019. Screening criteria includes funds with holdings of 90% or greater in U.S. equities and uses the oldest available share classes.

As shown above, although two mutual funds had a positive excess return over the stated benchmarks, none of the equity funds reviewed produced a statistically significant level of alpha, based on a t-stat of 2.0 or greater. (For a review of how to calculate a fund's t-stat, see the section of this study that follows the individual Legg Mason alpha charts.)

Why is this important? It means that if we wanted to simply replicate the factor risk exposures to these Legg Mason funds with indexes of the factors, we could blend the indexes and capture similar returns. 

To get similar risks and returns in a mutual fund would require the additional fees of those passively managed funds. That would alter such an analysis, but not by much because of the relatively low fees of the passively managed funds compared to the actively managed funds.

Conclusion

Like many of the other largest financial institutions, a deep analysis into the performance of Legg Mason has yielded a not so surprising result: Active management is likely to fail many investors. We believe this is due to market efficiency, costs and increased competition in the financial services sector.

As we always like to remind investors, a more reliable investment strategy for capturing the returns of global markets is to buy, hold and rebalance a globally diversified portfolio of index funds.

Below are the individual alpha charts for the existing Legg Mason actively managed mutual funds that have five years or more of a track record.


 


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Here is a calculator to determine the t-stat. Don't trust an alpha or average return without one.

The Figure below shows the formula to calculate the number of years needed for a t-stat of 2. We first determine the excess return over a benchmark (the alpha) then determine the regularity of the excess returns by calculating the standard deviation of those returns. Based on these two numbers, we can then calculate how many years we need (sample size) to support the manager's claim of skill.


Footnotes:

1.) Legg Mason, "Assets Under Management and Flows Report for March 2020," April 13, 2020. 

2.) Pensions & Investments magazine, "Can Legg Mason Stop the Leak for Franklin?" Feb. 18, 2020.

3.) Franklin Templeton, first fiscal quarter earnings report, Jan. 30, 2020.

4.) Morningstar, Greggory Warren, analysis of Legg Mason, April 15, 2020.   


This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. Performance may contain both live and back-tested data. Data is provided for illustrative purposes only, it does not represent actual performance of any client portfolio or account and it should not be interpreted as an indication of such performance. IFA Index Portfolios are recommended based on time horizon and risk tolerance.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.