Western Asset to overtake PIMCO

PASADENA, Calif. — Western Asset Management Co., the smallest of the three money managers dominating the U.S. fixed-income market, soon will become the biggest, leading some competitors to predict the extra size won't agree with the high-flying bond shop.

WAMCO will gain about $280 billion in assets when parent Legg Mason Inc. completes a swap of its brokerage operations for Citigroup Inc.'s asset management arm. The deal is expected to be completed by Dec. 1.

The addition of Citigroup's assets, coupled with a stretch of torrid organic growth, will give Western Asset roughly $520 billion under management, barely nosing out the $514 billion longtime market leader Pacific Investment Management Co., Newport Beach, Calif., had as of Sept. 30. BlackRock Inc., New York, the third member of the so-called bond oligopoly, managed $428 billion as of Sept. 30.

Competitors say that market-topping scale could prove to be a bigger hurdle for WAMCO than it has for PIMCO because of WAMCO's more bottom-up investment style.

"Size is a deterrent for them," said the head of fixed income with a Boston-based firm, who declined to be named. PIMCO makes money on big macro trades, while WAMCO's style relies more on individual security selection. WAMCO's added size will increasingly force the firm into PIMCO's territory of sector rotation, he predicted.

Another fixed-income veteran said Western Asset's size was already unwieldy, so the addition of Citigroup's assets will make it "prohibitively difficult" to move out of positions, even with the largest corporate issuers.

Market watchers are hard-pressed to name a fixed-income acquisition even remotely close in scale to this one.

Clients and consultants say size is an issue, but Western Asset Management's strong corporate culture and superior track record leave them more than willing to give the firm the benefit of the doubt.

WAMCO has continued "to meet or exceed our expectations," said William Atwood, executive director of the $11 billion Illinois State Board of Investment, Chicago. "I'm confident in their ability to manage this acquisition," he said. WAMCO manages $441 million in core-plus assets for the Illinois board.

WAMCO's flagship U.S. equity core-plus strategy, with more than $60 billion, has set the pace in recent years among big bond houses. Spectacular returns in 2003 and 2004 more than offset a rough 2002, market watchers said.

"The amount of additional assets in the core-plus space (coming from Citigroup) is not huge," noted Ron Schmitz, the director of investments for the $52 billion Oregon Public Employees' Retirement Fund, Salem. As with all "corporate events," Oregon is following the situation closely, but "at this point, we have no strong concerns," Mr. Schmitz said. The firm manages $2.5 billion in core-plus assets for Oregon.

When the deal was announced in June, Legg Mason said the asset swap with Citigroup would lift WAMCO's $95 billion in U.S. core and core-plus assets by only $13 billion.

In the swap with Citigroup, Western Asset will gain more than $110 billion in money market assets and about $40 billion in municipal bonds. WAMCO also gets $15 billion to $20 billion in non-U.S. single currency bond assets in Asia and Brazil, which sources say is much needed to compete with PIMCO and BlackRock in that area.

Some observers say pigeonholing the firm as a bottom-up credit picker — as some of its competitors do — is out of date.

The investment styles of PIMCO and WAMCO are closer than many people think, said Jeff Nipp, director of investment manager research at Watson Wyatt Consulting in Atlanta. "Any good manager evolves over time," and with over a quarter of a trillion dollars in assets, WAMCO long has had to grapple with an environment where it couldn't rely on issue selection alone, he said.

One industry source, who as a corporate pension executive hired WAMCO, said the firm has shown a "good sense of timing," recognizing value when a sector is too rich and making quick adjustments. Another veteran said that while William H. Gross, PIMCO's chief investment officer, is the best-known member of a tiny fraternity of managers who "consistently added value through duration," WAMCO CIO Kenneth Leech is on everybody's short list as well. (As for Citigroup's CIO for fixed income, Peter J. Wilby, sources expect him to leave to start his own firm in about three months.)

But even if WAMCO isn't a pure credit shop, many observers cite the firm's issue selection as especially impressive. For example, in picking Mr. Leech's core bond team as fixed-income manager of the year in 2004, Morningstar Inc. said the team "makes duration, yield-curve and sector bets, but it's really the credit work that stands out."

A Legg Mason spokeswoman said neither Mr. Leech nor Jim Hirschmann, WAMCO's president and CEO, would comment for this story.

Competitors say the Citigroup acquisition will pose an added layer of risk for WAMCO, should its stellar gains of 2003 and 2004 give way to a stretch of underperformance anytime soon.

Western Asset's one- and three-year returns for its core-plus strategies remain solidly top decile, but the firm had a few rough months more recently.

According to data provided by Lipper Inc., New York, the institutional share class of the Western Asset Core Plus Bond fund was in the second percentile of Lipper's intermediate U.S. fixed-income universe for the three years through Nov. 22, compared with the 17th percentile for PIMCO's total return fund.

For the 12 months through Nov. 22, the WAMCO fund was ranked in the ninth percentile; PIMCO's fund was in the fourth.

But for the three months ended Nov. 22, the WAMCO fund ranked 466 of 469 funds ranked, putting it in the 100th percentile; the PIMCO fund was in the 18th percentile.

"Many of their clients have arrived on the doorstep in the last few years," and if WAMCO suffers a stretch of weak numbers now, they'll be open to charges that they've taken their eye off the ball, said an executive with one California-based bond shop, who declined to be named.

WAMCO's website, which provides data through the end of 2004, shows roughly 40% of the firm's clients hired WAMCO since the start of 2003.

But WAMCO fans argue against reading too much into a short-term stumble.

At the end of the day, WAMCO has proven itself to be a firm that attracts and retains "really great investors," said Michael Rosen, a principal with consultant Angeles Investment Advisors, Santa Monica, Calif. They take risks, so periods of underperformance can be expected, but "anyone who criticizes Western at this point in the game is either incredibly shortsighted or just jealous," he said.