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Rating:Can Legg Do Damage with an Alts Army? Not Rated 0.0 Email Routing List Email & Route  Print Print
Wednesday, March 05, 2014

Can Legg Do Damage with an Alts Army?

Reported by Tommy Fernandez

So, Legg Mason is buying QS Investors Holdings, a quantitative equities shop of no small repute.

Legg is also wasting no time consolidating its own quant operations into QS and under the helm of QS founder Janet Campagna and QS chief investment officer Rosemary Macedo.

Moreover, according to a company statement, it appears this purchase will serve as a foundation for a broader push into alternatives territory.

So, is Legg ready to kick some alts?

"I'm skeptical," says Shannon Zimmerman, Morningstar's associate director of fund analysis who follows Legg among other fund companies.

But before we go into Zimmerman's points, a few more details about the pricing of the QS deal, thanks to SEC filings.

According to Legg's 8-K filing, "In connection with the acquisition of QS Investors, the Company will pay consideration consisting of an initial purchase price of $11 million plus up to an aggregate additional $30 million contingent upon the achievement of certain net revenue targets during the 2nd and 4th years following the acquisition. "

Also, according to the same filing, "the Company expects to incur restructuring and transition costs of approximately $35 million, including $3 million in the quarter ending March 31, 2014, $30 million in fiscal year ending March 31, 2015, and $2 million in the fiscal year ending March 31, 2016. These restructuring and transition costs include employee related costs of approximately $30 million and certain other costs."

The full SEC filing of the deal can be found here.

Now about Zimmerman's common sense points about Legg's entry into alts.

It is important to note that Zimmerman is note raising any issues, whatsoever, about Legg or QS in particular. Both are perfectly respectable names with solid reputations. Legg's parent company is well known as an acquirer of fund firms that have solid core expertise's, and then provides distribution for these acquisitions, Zimmerman notes.

Rather, Zimmerman raises questions about what he describes as the "Gold Rush" of fund firms racing into liquid alts, whether or not they have a demonstrated capability in this investment category.

Point #1: Fund firms have succumbed to Gold Rushes in the past, and paid for them. Cases in point, the tech stock and real estate booms of previous decades.

"It is interesting to see the trend into alts echoes what happened with tech funds in the '90s and real estate in the '00s. There is a lot of money moving into this. This is a Gold Rush," he said.

To be sure, Zimmerman allowed, firms have to meet investors "halfway" many times and meet the demand for new products, but not all firms have weathered through such trends, especially if they don't have long-term expertise in the product categories. And if such trends whipsaw, the funds' managers will be forced to into nasty transactions to provide cash for the redemptions, always a bad situation to be in. Such a situation brought down many a firm during the other previous Gold Rushes, he said.

POINT #2: There still isn't strong general consensus amongst investors that alts are an absolutely necessity for portfolios.

Granted, more people have developed an appreciation for alts and the potential downside protection they may offer, ever since the 2008 Financial Crisis. However, Zimmerman said, even the best alts funds have lagged behind more mainstream equity funds since then. Not everyone is convinced they really need these products.

"You can be the best in the world in a particular product, but what happens if most people aren't certain they need it?" Zimmerman asked.

Alts are notorious for being sold, not bought, Zimmerman said, especially given the higher fees. If Legg is to succeed in this category, among other things, the firm needs to convince the market that they really want what it has to offer. 

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