News that co-CIO Ken Leech, the institutional face of Western Asset Management, stepped down last week under a regulatory cloud will test the patience of clients who have had to stomach patchy performance by the firm in recent years and high level turnover even prior to Leech's exit.
Some, apparently, have already seen enough.
At an Aug. 27 meeting, the investment committee of the $12.5 billion Chicago Public School Teachers’ Pension & Retirement Fund voted to recommend that its trustees terminate Western's $550 million core-plus fixed-income mandate when the board next meets on Sept. 19.
Analysts predict other institutional clients could follow suit, with near-term concerns about a Securities and Exchange Commission investigation being added to the mix.
Longer term, the 34-year veteran’s abrupt departure — amid a stretch of middling performance on the back of a premature bet on central bank easing — seems likely to push back the day when the well-respected manager of $381 billion in fixed-income assets is finally able to return to the front foot, analysts say.
Parent company Franklin Templeton, in an Aug. 21 SEC filing, said the SEC recently issued a Wells Notice to Leech, identifying him as a target of an investigation focusing on “past trade allocations involving treasury derivatives."
The filing noted that with Leech stepping aside, Michael Buchanan — a 19-year Western veteran named co-CIO in 2023 — had been named as sole chief investment officer.
'Seamless transition'
In the filing, Jim Hirschmann, Western’s long-time president and CEO, predicted a “seamless transition,” with both clients and Western’s investment teams “in good hands.”
It remains to be seen how well Western will be able to roll with the latest punches.
Elbie Louw, a senior analyst with Morningstar, said the departure of a decision-maker with such a significant influence on investments throughout the organization has left Morningstar's team working to parse his influence, strategy by strategy, with the goal of reassessing "our level of conviction" on each.
Leech “was a significant investment influence and decision-maker within the organization, specifically on the macro side, so that for us is important to consider,” Louw said. “Analysts need to determine how his influence differed across strategies — whether his involvement was from a macro point of view or on a day-to-day management basis — as well as considering the portfolio management team running the assets and supporting resources,” she said, adding that the diligence effort is going to take “a bit of time.”
More departures
Leech, meanwhile, isn’t the only high-level investor at Western to step aside in recent months.
The latest monthly manager review by the $24.2 billion Public Employee Retirement System of Idaho, for whom Western was managing a $305 million global core full discretion mandate as of June 30, said recent departures from the firm included John Bellows, a portfolio manager and key member of Western’s global investment team; Chia-Liang Lian, the firm’s head of emerging markets debt; and Keith Luna, a long-time portfolio manager and analyst. Those departures were all employees with between 11 and 21 years at Western.
The Idaho pension fund's reports show that even ahead of the Leech news, Western had been reporting net outflows, of just over $500 million in July and more than $1 billion in June. With Leech now absent from an investment process he dominated over the decades, analysts see those outflows accelerating.
Given Leech’s high profile within the firm, “we anticipate further pressure on redemptions across the Western franchise,” wrote Dan Fannon, a managing director – equity research with investment bank Jefferies Group, in an Aug. 21 note.
That, in turn, should weigh on the parent company’s net flows, with Western accounting for more than 23% of Franklin Templeton’s AUM at the end of June.
For long-term strategies, Franklin Templeton reported negative net flows for six of the last eight quarters.
Morningstar analyst Greggory Warren, in an Aug. 21 report, warned that the sidelining of Leech, coming so soon on the heels of Bellows’ unexpected departure in May, “could lead to a loss of confidence for a firm that caters primarily to institutional clients” — prone to terminating relationships following the departure of key personnel or reports of government investigations.
The scrambling of Western’s investment leadership comes 10 years after another, even higher profile move — “bond king” William H. Gross’s decision to bolt from Pacific Investment Management Co., the firm he founded in 1971, to join Janus Capital Group.
This time around, Franklin Templeton executives can only hope that history doesn’t repeat itself, or even rhyme.
PIMCO, which in September 2014 boasted well over five times Western’s current AUM, suffered net outflows of more than $65 billion over the two quarters following Gross’ departure. PIMCO’s net flows stabilized within a year and eventually turned positive again but it still took the firm roughly five years to top the $1.88 trillion in AUM it reported as of Sept. 30, 2014.
Majority institutional
Institutional clients account for roughly 65% of Western's assets.
A number of clients — including Kansas Public Employees Retirement System, the Public Employees' Retirement System of Idaho and the California State Teachers' Retirement System — either didn't respond to requests for comment or declined to comment about the latest developments at Western.
Among clients who did respond, Fernando Vinzons, Chicago Teachers' CIO, said in an email that his team placed Western Asset Management on CTPF’s watchlist in June, following the departure of Bellows, co-manager of the Western core-plus strategy Chicago Teachers had $550 million invested in.
Vinsons couldn't be reached for comment on his investment committee's Aug. 27 decision to terminate Western.
Other clients said determining whether or not their strategies were impacted by the trade allocations involving treasury derivatives at the center of the SEC’s investigation of Leech was the first big hurdle they need to clear.
A statement provided by Oregon State Treasury said Western had informed OST that Oregon's public pension fund money being managed by Western was “not within the scope of the SEC investigation.”
“We are carefully monitoring this situation to ensure prudent and responsible fund management continues,” the OST statement concluded.
A third institutional client, who declined to be named, said the latest developments at Western call for a considerable amount of due diligence and if that leads to a conclusion that Western, a very trusted partner, has changed, “we will act."
"It has our attention. We’re on it and we’ll see how this turns out,” but sticking with good managers through tough times is often the key to achieving superior returns over the long term, the client noted.
Some analysts expect there to be institutional clients who prove less patient.
Morningstar’s Warren predicts that with the departure of Leech, Franklin could suffer outflows of between 1% and 3% a year between 2024 and 2028, worse than his prior estimate of flat to outflows of 2% a year.
Governance in focus
The latest developments shine a spotlight on parent company Franklin Templeton’s governance structure, industry veterans say.
In a financial services industry where a "crystal clear chain of command and universal oversight of compliance" have come to be accepted as best practices, Franklin's family governance and complex business structure could increasingly be seen as a competitive disadvantage, noted Donald Putnam, founder and managing partner of Grail Partners, a San Francisco-based investment banking boutique focused on the money management industry.
In contrast to competitors such as BlackRock and J.P. Morgan, "Franklin's 'chain of command' is not straightforward, which can lead to lax oversight and slow reaction to bad actors," Putnam said.
Morningstar’s Warren concurred, noting that the Western imbroglio now “speaks to our long running criticism of Franklin’s use of a hands-off approach to run its different investment franchises."
A Franklin Templeton spokeswoman said the challenges facing Western now should be seen in a narrower context — an "isolated incident that was self-identified by Western."
"Its scope is limited to specific, past trade allocations," she said.
Still, the news about Leech's Wells Notice has clearly jolted investors, prompting a hefty 12.6% sell-off of Franklin's stock on Aug. 21 to $19.78. Franklin's shares have since rebounded roughly 2.8% to $20.34 over the following four sessions, while the S&P 500 was essentially flat over the same period.
