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Legg Mason moves beyond traditional mutual funds, leaning on affiliate for ETF offerings

While some asset managersexperienced significant mutual fund outflows in the first half amid increasedcompetition from exchange-traded funds, Legg Mason Inc. was not one of them. According to ThomsonReuters Lipper, Legg Mason benefited from $279 million of net inflows. Some ofthe strongest asset gatherers were Western Asset Core Plus Bond and WesternAsset Mortgage Backed Securities.

The company in late 2015entered the ETF market with four equity products, including Legg Mason USDiversified Core (UDBI) and Legg Mason Low Volatility (LVHD). Tom Hoops, headof business development for Legg Mason, leads the company's mergers andacquisition and global product development, working with the executive team,investment affiliates and global distribution.

Hoops recently spoke to ToddRosenbluth, director of ETF and mutual fund research at S&P Global MarketIntelligence about how the company entered the ETF space, the potential foractive products and the likelihood for additional industry consolidation.

Below is an edited transcriptof the discussion.  

S&P Global MarketIntelligence: Legg Mason launched four smart-beta ETFs in late 2015. How arethese positioned differently than some of your peers' products, includingthose from BlackRockInc., Goldman SachsGroup Inc., and JPMorgan Chase & Co.?

Tom Hoops: Three of the four productsleverage proprietary diversified base investing processes that our affiliateQS Investors LLC hasbeen running for institutional clients for 15 years. The general philosophy isto develop better diversification and create better beta for clients. We have aU.S. product, a developed ex-U.S. product, and an emerging markets product.UDBI is positioned as a complement or substitute for market-cap weightedpassive allocations to the S&P 500 index. We are hearing increasingly fromclients on concerns about the drawbacks of market-cap weighted strategies thatcontinue to allocate more money to stocks that have gone up in value and lessto stocks that have gone down. So our products are intended to be a betterexpression of risk premium.

The fourth product is focusedon low volatility anddividends, some of the most popular themes thus far in 2016. However, what doyou think of some of the industry concerns that they have become too popular?

Oneof our ETFs, LVHD, is based on research QS Investors has done focusing not juston the highest dividend yielding stocks, as some products do, but onsustainably high dividends. Across many of our affiliates we managelow-volatility portfolios on an active basis. We don't think of it as a trade,but rather an enduring need of clients. They need to have the growth potentialequity exposure provides. But given where we are in the market cycle and whereinvestors are in their life cycle, the typical volatility of the stock marketcan be troublesome. We also think low-volatility investing has been rewardingover time, but as with all investment styles, interest can ebb and flow in ashorter period.

You have a number of otheraffiliates with strong intellectual property that could be leveraged as ETFs.Are there other efforts underway?

LeggMason has nine different affiliates specialize in certain asset classes. Wemanage well over $700 billion in global assets through not just mutual funds,but insurance products, collective trusts and separately managed accounts. Butwe view ETFs as a wrapper to deliver our investment strategies when it makessense to do so, whether it is through active products or smart-beta ones.

Do you think both ETFs andactive mutual fundswill continue to have a key role in investment portfolios?

Muchof the demand for ETFs has been driven by market cap weighted passive products.But the ETF vehicle can be used to deliver other strategies such as rules-basedsmart beta. While the active ETF space is nascent it could grow over time asclients like the lower operating costs and tax efficiency aspects. We don'tthink investors should think active or passive but active and passive.

Your bond mutual fundsexperienced strong inflows this year. What do you think is driving interest inyour company's Western-managed mutual fund products?

,one of our fixed-income affiliates, has a broad suite of products. They havedone a great job in delivering strong performance and gathering assets. Fixedincome remains a meaningful portion of a client's portfolio, regardless oftheir objectives. Bonds can be a trickier asset class when interest rates areso low, but that's a benefit of a firm having products that go beyondtraditional core offering. Another affiliate we have offering global fixedincome is Brandywine GlobalInvestment Management LLC and it too has experienced strong demand.

Do you think the increasedregulations in the asset management industry, including the Department ofLabor's fiduciarystandards, will spur further industry consolidation?

Therewill be more consolidation, but not because of the DOL rule. Every day in ourindustry, the bar is set higher for scale benefits. To meet client needs with aglobal set of products and to deal with the fixed costs, including compliance,technology and cybersecurity, is harder than before. The days of running asmaller boutique, generating decent performance and the flows will find you arebehind us. Increasingly, many firms are entertaining how they can partner withsimilar-sized firms or larger firms to get access to the infrastructure. Ourmodel is purposely designed to allow our affiliates to focus on their craft andhave them own culture, but connect to a global asset management firm with broaddistribution and access to capital.