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Edited Transcript of LM earnings conference call or presentation 1-Aug-19 9:00pm GMT

Q1 2020 Legg Mason Inc Earnings Call

BALTIMORE Aug 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Legg Mason Inc earnings conference call or presentation Thursday, August 1, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan F. Magleby

Legg Mason, Inc. - MD & Head of IR

* Joseph A. Sullivan

Legg Mason, Inc. - Chairman, President & CEO

* Peter Hamilton Nachtwey

Legg Mason, Inc. - CFO & Senior EVP

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Conference Call Participants

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* Christopher Meo Harris

Wells Fargo Securities, LLC, Research Division - Director and Senior Equity Research Analyst

* Craig William Siegenthaler

Crédit Suisse AG, Research Division - MD

* Daniel Thomas Fannon

Jefferies LLC, Research Division - Senior Equity Research Analyst

* John Joseph Dunn

Evercore ISI Institutional Equities, Research Division - Associate

* Kenneth S. Lee

RBC Capital Markets, LLC, Research Division - Analyst

* Macrae Sykes

G. Research, LLC - Research Analyst

* Michael J. Cyprys

Morgan Stanley, Research Division - Executive Director and Senior Research Analyst

* Michael Roger Carrier

BofA Merrill Lynch, Research Division - Director

* Robert Andrew Lee

Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst

* William R. Katz

Citigroup Inc, Research Division - MD

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Presentation

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Operator [1]

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Welcome to the Legg Mason First Fiscal Quarter 2020 Earnings Call. My name is Brandon, and I'll be your operator for today's conference call. (Operator Instructions) Please note, this conference call is being recorded.

It is now my pleasure to introduce your host, Alan Magleby, Head of Investor Relations. Thank you. Mr. Magleby, you may begin.

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Alan F. Magleby, Legg Mason, Inc. - MD & Head of IR [2]

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Thank you, Brandon. On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2020 first quarter ended June 30, 2019.

This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance and are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements. For a discussion of these risks and uncertainties, please see Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations in the company's annual report on Form 10-K for the fiscal year ended March 31, 2019, and in the company's subsequent filings with the Securities and Exchange Commission.

During today's call, we may discuss non-GAAP financial information. Reconciliations of non-GAAP financial information to the comparable GAAP financial information can be found in the press release and in the presentation we issued this afternoon, which is available in the Investor Relations section of our website. The company undertakes no obligation to update the information contained in this presentation to reflect subsequently occurring events or circumstances.

Today's call will include remarks from Mr. Joe Sullivan, Legg Mason's Chairman and CEO; and Mr. Pete Nachtwey, Legg Mason's CFO, who will discuss our financial results. In addition, following a review of the company's quarter, we will then open the call to Q&A.

Now I would like to turn this call over to Mr. Joe Sullivan. Joe?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [3]

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Thanks, Al. Good evening, and as always, we welcome and appreciate your continued interest in Legg Mason.

With me tonight is our CFO, Pete Nachtwey, as we review our performance for the first fiscal quarter of 2020. This quarter's solid operating results once again demonstrate the impact of the diversification of our business. We realized long-term net inflows of $1.1 billion led by fixed income and alternative net flows across multiple geographies and channels, which more than offset equity outflows in the quarter. Our short-term investment performance improved as our manager's macro calls in fixed income began to play out, the leadership in equity markets broadened and quality-oriented investing was rewarded. As a result, our affiliates are seeing increased pipeline activity, particularly in equity and fixed income categories, where they have strong investment performance.

Western is seeing increased surges in credit from corporate clients looking to derisk their equity portfolios. ClearBridge has a strong pipeline in large cap, international and small cap as well as growth income strategies. And Martin Currie is attracting good interest in their emerging market equities and long-term unconstrained products.

Now let's move to our 4 key drivers of value creation that we discussed last quarter and on which we remain very focused. I'm pleased that we have made progress in each area. And just to remind you, those drivers are leveraging our centralized retail distribution to drive growth, capitalizing on our investments to provide investors with greater choice, more effectively controlling our costs to improve profitability and thoughtfully managing our balance sheet and capital allocation. Because I know it remains a topic of particular interest to you, let's start with improving profitability by more effectively managing costs.

We are well underway in attaining the savings that we targeted under our broad strategic restructuring program, and we now expect the cost to achieve those savings to be less than originally estimated. We continue to project annual run rate savings of $100 million or more over the 2-year period ended March 2021. And we are pleased to have achieved 40% of our run rate savings by this past July 1, and we now expect to realize 80% or more of total run rate saves by this fiscal year-end.

Now let's move to leveraging our retail distribution platform. While operating with a high degree of efficiency is essential, we know we can't succeed long term by simply cutting costs. And so we are also investing for growth in retail channels around the world. Embedded in our corporate strategy is the diversification of our business, which is also reflected in our approach to retail distribution. Overall, retail net sales were up quarter-over-quarter and up substantially year-over-year with positive net sales in most channels and regions.

Much like last quarter, we realized growing market share in core businesses with strong investment performance such as U.S. taxable fixed income, large-cap growth and international equities. Further, working closely with one of our global distributors, we successfully launched a fixed maturity product with Brandywine Global, raising over $600 million. Now while this offering was primarily distributed in Asia, we were able to use it to expand our retail distribution footprint in new markets, notably in Bahrain, Greece and The United Arab Emirates. This was the second such product launch with this partner, building upon the first offering which we did with Western Asset that raised over $450 million in the first calendar quarter of this year.

The increasing breadth of our investment strategies and vehicles also represents a source of resilience in the face of flow pressures. And we are now seeing flow momentum begin to build in certain new initiatives. For example, the Martin Currie Emerging Markets Retail SMA, which achieved U.S. retail platform placement last quarter, saw measurable inflows this quarter. QS has continued to win new model placements, with 6 launched this past quarter and 4 others in the pipeline. We also saw increased interest in active ETFs in the U.S. as well as in Australia, where we launched our fourth ETF in partnership with BetaShares.

As we have demonstrated, close partnerships with distributors are increasingly important, and to that end, we were pleased to announce in June a strategic alliance with Corporación Actinver, bringing ClearBridge, Martin Currie and Western to retail investors in Mexico to one of the country's largest private banks. With increases in both the population and the number of people accessing banking services, we see meaningful long-term growth potential in Mexico.

Now let's talk about capitalizing on our investments. Developing the potential of the strategic investments that we make enables us to provide clients with greater choice and makes our business stronger through the greater diversification and the resiliency that results. Our investment in Precidian is an excellent example. As many of you know, in late May, the SEC granted exemptive relief for Precidian's nontransparent ETF structure called ActiveShares. The interest in ActiveShares has been significant, with a growing list of managers now evaluating this nontransparent and more efficient vehicle. We'll keep you up-to-date with our progress in launching new strategies utilizing the capability.

But we're also helping our affiliates expand the reach of their businesses. Two developments with Clarion highlight these types of opportunities. Last quarter, I mentioned Clarion's acquisition of Gramercy Europe, a pan-European real estate manager. Expanding Clarion's geographic reach is important as is accessing new, untapped channels for them. We recently received SEC approval for the Clarion Partners Real Estate Income Fund, which will bring Clarion's institutional private equity real estate capabilities to the U.S. retail market through Legg Mason for the first time. We have begun to market the fund into the wealth management channel and expect retail shelf space availability for the fund in the early fall. This product is a good example of how we can help to meet the demand by the retail investor for alternative investments and uncorrelated returns.

While developing new products is important to continue attracting retail investors, we are also mindful of the need to connect with them in new and different ways. You've heard in the past about our investments in Financial Guard in the U.S. and Quantifeed in Asia that were made as part of our global alternative distribution strategy.

In July, we announced a strategic minority investment in Embark Group, a U.K. retirement solutions provider. Embark is one of the fastest growing digital retirement and savings platform in the U.K. market, having grown from 0 to GBP 15.5 billion in assets under administration in less than 6 years. It is yet another example of extending the scope of our distribution capabilities, in this case, into the independent financial advisory market in the U.K. by leveraging new digital technologies.

Finally, in the context of managing the balance sheet. Last quarter, we announced that our Board of Directors had approved an 18% increase in our annual dividend, marking our 10th straight year of dividend increases. And last month, as planned, we repaid $250 million of our outstanding senior notes. We will continue to thoughtfully consider capital allocation alternatives, which we do see as critical to creating shareholder value over time.

Now before I turn the call over to Pete, I'd like to update you on some important developments with our Corporate Board. Legg Mason has been a public company for over 35 years, and we have had many distinguished members serve on our Board of Directors over that time. Two days ago, we held our annual meeting at which this year's slate of directors were elected. And as a result, I would now like to recognize the 4 directors who have left our Board: Barry Huff, Allen Read, Peggy Richardson and Kurt Schmoke. I would personally like to thank them and express my gratitude for the insights and ideas that they've shared with us over the years as well as their many contributions that have helped Legg Mason to navigate the evolution of the industry and our business. Our shareholders have benefited from their service. I have valued their counsel, and we all appreciate their outstanding contributions to our success.

As part of this Board refreshment process, we are pleased to have welcomed Nelson Peltz and Ed Garden of Trian Partners to our Board in May as well as Steve Hooley, the former Chairman and CEO of DST Systems, who was elected to the Board earlier this week. We look forward to their fresh perspectives and benefiting from their experience and are confident that their insights will benefit Legg Mason and position us for continued growth.

And with that, Pete, let me turn it over to you.

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [4]

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Thanks, Joe. I'll start off with the highlights on Slide 2. Legg Mason reported net income of $45 million or $0.51 per share, including strategic restructuring charges of $33 million or $0.27 per share. This quarter, we also started disclosing new non-GAAP measures, which included adjusted net income of $67 million or $0.75 per share. And as a reminder, on adjusted EPS, we include unvested participating shares in that calculation. And for fiscal Q1, that adds an additional 2.9 million shares to the denominator.

We also made meaningful progress on our strategic restructuring efforts, where, as Joe noted, we are continuing to project $100 million or more of savings. And I'll go a little deeper on some of the periodic P&L impacts in a moment.

Moving on to AUM. Our quarter end assets under management were $780 billion. In the quarter, we had long-term net inflows of $1.1 billion, including $3.9 billion in fixed income and $800 million in alternatives, but these were partially offset by equity outflows of $3.6 billion.

Net sales were strong across our global distribution platform at $4 billion, up from $2.5 billion in the March quarter. Investment performance remains strong, with 78% and 79% of strategy AUM beating benchmarks for the 3- and 5-year periods, while 66% and 72% of AUM beat Lipper category averages for the same periods.

Now let's look at our affiliates on Slide 3. 5 of our 9 affiliates saw a positive or breakeven net long-term flows for the quarter across our fixed income and alternative managers, while our equity affiliates experienced outflows. Unfunded wins and committed uncalled capital were down from the prior quarter primarily reflecting fixed income fundings at both Western and Brandywine.

Turning to Slide 4. You can see the asset class mix of our unfunded wins, and committed uncalled capital remains diverse with 42% coming from alternatives, 34% from fixed income and 24% from equities. Furthermore, the $3.7 billion of unfunded fixed-income wins are spread across multiple flagship strategies with a similar diversification story holding true for the $2.7 billion in equities.

Finally, regarding alternatives, we are very pleased that our unfunded wins and committed uncalled capital remained strong at a combined $4.6 billion.

Slide 5 highlights our global distribution platform. Notably, our gross sales increased 5% for the quarter on a sequential basis. But more importantly, this was the best June quarter for gross sales in LMGD's history. At the same time, redemption rates meaningfully declined. And as a result, we saw positive net sales of $4 billion for the quarter, including net contributions from 11 of 13 channels and regions. And our U.S. mutual fund net sales were the highest since December 2014, while we took market share across both taxable fixed income and international equities.

Moving to Slide 6. I already highlighted our bottom line earnings, so I'll move on to operating revenues, which increased by $13 million or 2%, driven by higher average AUM and one additional day in the quarter, which were then partially offset by a decline in performance fees. We estimate that next quarter's non-pass-through performance fees will be about $4 million, and pass-through performance fees should be in the range of $10 million to $15 million.

Our adjusted operating margin was 21.6% for the first quarter versus 20.4% in the prior quarter. This primarily reflects higher revenues and the impact of realized cost savings.

Finally, our GAAP tax rate came in at 23%, which includes the impact of certain discrete tax items and consolidated investment vehicles, while our cash tax rate was only 7% for the quarter. And for your adjusted earnings models, we expect next quarter's tax rate to be in the range of 27% to 28%.

On Slide 7, you can see that AUM increased due to a variety of factors, including market appreciation, long-term inflows, acquired AUM and FX gains, partially offset by liquidity outflows. The operating revenue yield came in at 37 basis points, in line with the prior quarter and reflecting higher average equity and alternative AUM offset by slightly lower fixed income yields.

Operating expenses, on Slide 8, increased by $6 million primarily due to a $24 million increase in strategic restructuring charges. Excluding those charges, expenses were down $18 million as higher D&S expenses were more than offset by higher restructuring savings and lower compensation and business-as-usual expenses.

Turning to Slide 9. Our comp ratio for the quarter was 57%, up from the prior quarter and slightly higher than our forecast. This was driven by higher commissions, certain seasonal factors and revenue share affiliate incentives benefiting from their lower other operating expenses. Total comp and benefits increased by $24 million, with $29 million stemming from higher restructuring costs which were partially offset by the lower mark-to-market on deferred comp and seed, lower affiliate charges and lower pass-through performance fees. Next quarter, we expect our comp ratio to decrease to a range of 54% to 56%, reflecting a reduction in seasonal expenses and savings from our strategic restructuring.

On Slide 10, our adjusted operating margin has been revised to be consistent with our new adjusted earnings definition. For the quarter, the adjusted operating margin increased primarily due to savings from the strategic restructuring and higher net revenues partially offset by higher seasonal comp factors. We would expect next quarter's margin to improve due to the combined impacts of additional restructuring savings, lower seasonal comp and one additional day in the quarter.

Slide 11 is a roll forward from fiscal Q4's adjusted EPS of $0.67 to this quarter's $0.75. The EPS improvement reflects $0.05 of additional restructuring savings and another $0.05 from higher net revenues. These were partially offset by seasonal comp increases and higher sales commissions, which combined to reduce adjusted earnings per share by $0.06. And finally, fiscal Q1 benefited from a lower adjusted tax rate and other items, which increased earnings per share by $0.04.

On Slide 12, we have updated the schedule depicting savings and associated costs of our restructuring program. To orient you by section of the table, we have columns showing the relevant time periods for your models, and the line items start by showing the incremental saves realized in each period, then the cumulative saves realized by P&L line item, followed by run rate percentage saves realized as each -- as of each period end. And then finally, the incremental and cumulative costs to achieve these savings. So as you can see in the fiscal 2021 column, our savings target remains at $100 million or more, while our cost to achieve these savings are expected to be lower, now at an estimated range of $120 million to $140 million.

In fiscal Q1, which is the second column, we reported $10 million of savings, with cumulative savings realized now at $14 million. We expect to realize an additional $15 million in savings in fiscal Q2, followed by another $41 million in the last half of the fiscal year, bringing cumulative savings to $70 million by the end of fiscal 2020. We have now achieved run rate saves of 41% effective with a number of departures at the end of our fiscal first quarter. And we remain on target to capture over 80% of run rate saves by fiscal year-end.

You can also see on the schedule that on our projected savings for fiscal Q2 and for the full current fiscal year, we replaced the percentages we used in last quarter's earnings deck with specific dollar amounts. But just be reminded that these are still projections, so actuals may differ somewhat from these numbers, especially due to rounding.

In terms of costs to achieve these savings, we had $33 million this quarter, and we're expecting an additional $20 million in fiscal Q2. For the second half of this fiscal year, we are anticipating costs of $32 million to $42 million, with additional costs of approximately $25 million to $35 million in fiscal '21.

So with that, let me turn it back over to Joe for his closing remarks.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [5]

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Thanks, Pete. Our strategy of expanding client choice and the resulting diversification of our business has served to create a greater degree of business resiliency at Legg Mason. Underpinning this strategy and all of our work is our mission of investing to improve lives on which we are passionately focused. By leveraging our retail distribution platform, capitalizing on our investments, operating with greater efficiency and thoughtfully managing our capital allocation, we can better achieve our mission, more effectively deliver on our strategy and create greater value for our shareholders.

And with that, we'll open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And from Citi, we have Bill Katz.

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William R. Katz, Citigroup Inc, Research Division - MD [2]

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Thank you for the added disclosure. It makes it much better for us to get the true earnings power of the company. Joe, I want to sort of pick up where you left off on terms of the Board composition. Sort of wondering if you can give us an update, maybe it's too soon but perhaps how should we be thinking about strategic priorities given the new Board representation? And I'm wondering if you could weave in maybe your current affiliate mix and how you might better monetize the DTA.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [3]

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Okay. So with respect to our new Directors, both, I would say, Nelson and Ed as well as Steve Hooley, and by the way, I didn't mention this, but we have disclosed that we are likely to increase the size of the Board from 9 until -- 9 to 12 over the course of the next couple of months. And we've been interviewing a number of really exciting candidates. Look, I think there's 2 ways I think about it, Bill, it's pretty straightforward. I think we need to -- and I think the folks at Trian and Steve Hooley and everybody on our existing -- or returning directors believe and recognize that we need to operate with a greater -- much greater degree of efficiency in order to compete, in order to be able to invest in the business, to be able to return more to shareholders and create a greater margin. We are well on the way with that. Obviously, we've taken a lot of steps, and we're clearly well down the way on that path. At the same time, I think there's a sense that we need to operate with a much greater degree of effectiveness. And what I mean by that is, how we work together and come together to drive growth.

We do see that we've got a really terrific platform in terms of our world-class managers and the investment capabilities that they have, in terms of the breadth of products and vehicles that we have and in terms of our distribution footprint, both institutional, retail, U.S., non-U. S., traditional and increasingly digital. And so we've got all the pieces here. And so I think our new directors are coming in with a focus on how can we continue to improve and increase our efficiency as well as our effectiveness. Look, we've got -- we're excited about commercializing the investments that we've made. As I've mentioned, Martin Currie, we've got shelf space now with respect to their emerging market SMA. We've got -- we're really excited about the launch we've got with Clarion Partners and that fund, which we expect to be in the fall. EnTrust is going to be in the market with a strategy on a -- one of the large distributor platforms with their Blue Ocean direct-lending strategy. We've just got a lot going on with the newer affiliates, and then we just have everyday business going on in the kind of traditional strategies where we are taking share, taking share in fixed income, taking share in equities. And so there's just a tremendous amount going on. Pete, do you want to talk about the DTA for Bill?

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [4]

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Yes. I think quite frankly, Bill, the best way we can monetize the DTA is grow earnings. And as of right now, and as we continue to have the slides in the Appendix on Page 18 that shows the tax benefit, the biggest chunk of that $500 million of tax savings comes from utilizing our net operating loss carryforward, and that's going to be roughly in the next 4 years or so. I think implied in your question is if we did some sort of portfolio transaction, could that monetize it faster? Maybe, but I don't think that's really going to drive decision-making.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [5]

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Right.

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William R. Katz, Citigroup Inc, Research Division - MD [6]

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Okay. That's helpful. And then maybe just a follow-up question, it's a 2-part, so bear with me. Sort of wondering if you could give us an update on the July flows. And then the broader question is why do you think you're having better success in the retail channel relative to the institutional channel, we're sort of thinking about the sort of the give-and-take in terms of where you're seeing the gross sales versus the pipelines, et cetera.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [7]

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Sure, Bill. You're a master at this. You just got 5 questions in there. So congratulations. Look, as it relates to July, I'm going to caveat it, as I always do, that we still have basically a week to go with our institutional reconciliations. And that can take our numbers up, and it can take them down, we just don't know. But at the moment, I would say we look to be very modestly positive. But for some color around that, I would say it's interesting. We look to be out in equities, positive in fixed income but really nicely positive in alternatives. And that's good. I think the retail side of the business had a -- really a very solid month again. When you -- I think when you look at our institutional business, and I'm going to use the word that everybody asked us not to use anymore, which is lumpy, but the reality is, it is.

In our retail business, that oftentimes feels like more of a daily business where you're taking share, you're out in the field, you're winning new business and you're taking business away. The institutional side is the same, but the numbers are just bigger and they're not -- they're just not as frequent. Now we look at -- what we look at are a number of things when we think about our business. We look at unfunded wins, and unfunded wins are a good indicator, but they're just one. We also look at things -- good indicator for future business. We also look at things like the impact of investment performance, we look at the impact of market demand. And what we see right now, we're pretty excited about. We see a significant uptick in our activity level in our open opportunities. We saw, just quarter-over-quarter, a very significant percentage increase in those open opportunities. And I would say probably 20% to 25% of them we would put in the late-stage category. Pretty well-balanced between fixed income and equity, almost 50-50, a little bit more fixed income than equity.

But when you look at the improvement in our performance, the continued strength in our performance in fixed income and the improvement in our performance in equities, that's another good indicator along with unfunded wins. The consistency -- we're pleased of the level of alternative unfunded wins. That's just -- we just -- that's been a very consistent, and really, Clarion's just been something that's just been rock solid in terms of the consistency, in particular. The diversification, as I mentioned, of our unfunded wins between equity and fixed income. And then we're seeing Western reports, a really significant increase in activity and opportunities. And they represent a significant part of our open opportunities. And that really relates to searches for rebalancing. What they're hearing now is increasingly clients are looking to rebalance out of equities, which has obviously performed quite well and then for pension immunization trades that are out there. So we've -- it's -- again, it's lumpier, I'm sorry to say that, I know people don't like to hear that, but we are -- it also demonstrates really the diversification of our business. So we are taking share in the retail side, as I mentioned, in fixed income and equity. But we're also getting some nice international wins still in the institutional side. We've had some nice quasi-institutional wins in the U.S. So it's just a balance. We don't make too much of it or too little of it at any time.

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Operator [8]

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From Wells Fargo, we have Chris Harris.

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Christopher Meo Harris, Wells Fargo Securities, LLC, Research Division - Director and Senior Equity Research Analyst [9]

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On capital, do you guys feel like you can do something concurrent with the cost savings initiative that you're working to get through? Or do you want to get through the bulk of that first? And then secondly, how would you rank the various capital deployment options that you might be considering?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [10]

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So I think I've pretty much used this same opening phrase every time I get this question, but it's -- but I do it for a purpose. Our position on capital allocation and the priorities really is unchanged. As you know, we think about excess cash as the discretionary cash that we have following our CapEx and our tax obligations, our dividends, our debt service and then opportunities internally to invest and to support our business. We, as you know -- and I mentioned this in my prepared remarks, that we paid off our 2019 notes last month, and the good news is our next debt maturity is 5 years away. But as you alluded to, Chris, we've got some expenses related to our strategic restructuring. That's a priority use of that excess discretionary cash given the saves and the margin improvement that we're going to achieve as a result of it. But beyond those needs, we're going to continue to look at how we use our cash to invest in the business, maybe to delever and then to return capital to shareholders. And I would say, I'm prioritizing it, if we find opportunities to invest in the business that we think are more attractive to us and can be leveraged in a more meaningful way rather than just paying it out in dividends or returning it through a buyback, we'll do that. We're always going to look first at our business to see if there's a compelling opportunity to invest.

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [11]

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Yes, keep in mind, Chris, we did just do another very significant increase in the dividend, 18% last quarter. And I think probably the last 6, 7 years running, we've been at double-digit increases on the dividend, too. So we are kind of doing some things side-by-side with the restructuring. But Joe hit the priorities, I think, head on for the next 9 to 12 months.

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Operator [12]

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From KBW, we have Robert Lee.

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Robert Andrew Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [13]

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Maybe the first one, I know this doesn't come up too much, but can you talk a little bit about the cash management business? I mean we've seen kind of industrywide kind of resurgence, and obviously, why that's maybe been retail kind of resurgence and flows into cash management, yet it doesn't seem like you've been participating in that. Could you maybe -- and while it's certainly more modest fee, it could be a good margin business, certainly it could be additive. So could you maybe talk a little bit about strategically why you think you're kind of missing out on that and kind of the game plan around that?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [14]

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Sure. I think -- look, I think if you go back several years, our business evolved from being more balanced between a retail cash management business, a liquidity business with an institutional component to it. To -- you -- I mean this is, I don't know, long time ago, 7 years ago, 6 years ago maybe. We lost a significant part of that retail suite business. And then that business really became more of an institutional business and frankly, more concentrated in that way. But Western has made some pretty important hires in that space and is looking to build out that platform. And so it is a strategic piece of their business, a complementary piece of their business, they would tell you, I think, that a lot of their corporate clients for whom they have longer-term mandates also look at their liquidity business as a good place for corporate cash and things like that. So all I can tell you is it is a focus at Western, and they've been making strategic hires in that regard, and I think they're starting to make some progress there.

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Robert Andrew Lee, Keefe, Bruyette, & Woods, Inc., Research Division - MD and Analyst [15]

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Great. And maybe a follow-up, going to the Precidian, the nontransparent ETFs. But could you just remind us when you think you'll have the first products to market? I think it's pretty soon. But maybe as a follow-on to that, now you have the approval, and you've kind of starting to go through the process. How are you thinking about kind of maybe the education process that's going to be needed to get more advisers willing to use the product? I mean do you feel like that's going to be a fairly long ramp, short ramp? Just trying to get a sense of as you've kind of gotten more into the [weed] being here, how you're thinking about it progressing?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [16]

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So I think we are targeting the fourth calendar quarter of this year for the first launch of a product using ActiveShares. And I think that's probably a realistic time frame. If it slips, it will slip by a quarter or so. But I think the fourth calendar quarter of this year is realistic. I don't think -- I think there will be some education on this done, but remember this is, from a vehicle perspective, it is simply an ETF. And it's not -- there's not a whole lot more than that. Now what goes on behind the scenes and how all the pieces work, sure, an adviser is going to want to have a fundamental understanding of it. But at the end of the day, it's just an ETF. And a lot of the education for this really will be done at the home office level. I don't see us spending a ton of time in the field doing this, but I think a basic -- our wholesalers will spend some time, they'll introduce it. But I don't think it's going to be a massive education process to speak of.

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [17]

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Yes. And keep in mind, Rob, it's going to be -- we've signed up managers that represent well over core of the equity markets, some of the largest ones out there, and they have their own large sales forces. They're going to be the ones who are going to be educating distribution partners on the specific products as they come to market.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [18]

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Yes. That's a great point. We're not going to be going out with other distributors or other managers talking about this. So they'll do it.

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Operator [19]

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From G. Research, we have Mac Sykes.

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Macrae Sykes, G. Research, LLC - Research Analyst [20]

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Could you talk a little bit about how the Mexican partnership came to fruition? Was it a one-off? And then are you looking to do that perhaps in other geographies or other areas? Just what can we learn from that? And then secondly, a part of that, just thinking about the costs versus the ramp-up in revenue there, how should we think about that as well?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [21]

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So a couple of things. I would say, when I think about that, Mac, I think about sort of innovation in how you access different markets. So whether you're talking about partnerships where you leverage, we've done this with these fixed maturity products with a large global distributor in 2 -- in various markets around the world, we're actually leveraging into their sales force, right? And so we're partnering with them. We are -- our transaction and investment in Embark, we're utilizing a digital solution to access advisers in that particular case. With Quantifeed, we're going right to consumers with Cathay Bank in Hong Kong -- or in Taiwan, excuse me. And so what I -- the way I think about Actinver is in the context of sort of this notion of partnerships and alternatives distribution strategies. So we do not have a physical presence in Mexico. We do have 1 or 2 people who cover Mexico, but we don't -- we didn't open an office there. We looked for someone who we thought we could partner with and we could leverage their brand, we could leverage their presence in Mexico. So our costs there are frankly minimal. And it does give us access into that market. We know we're not going to have necessarily a physical presence with salespeople or brick-and-mortar in every country around the world. Mexico's a big one. And we do think it's a great growth opportunity. And just through some relationships that were developed over time, this kind of a partnership has come together. And we're going to look -- we already look to do that with other -- in other parts of the world. So it's just a -- it's a cost-effective way for us to access more parts of the investing public around the world.

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Operator [22]

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From Crédit Suisse, we have Craig Siegenthaler.

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Craig William Siegenthaler, Crédit Suisse AG, Research Division - MD [23]

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I'm wondering if you think you could create value for shareholders by selling one of your affiliates, especially one that wasn't generating significant internal synergy with the center.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [24]

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Look, we're really happy with the lineup of capabilities that we have. We haven't done an acquisition for a few years, we -- because we're -- the lineup that we have has been pretty thoughtfully constructed. And I think at any given time, a certain affiliate may be struggling a little bit or maybe more active with our distribution platform or less active with our distribution platform, but we're not -- we don't trade, we don't think about affiliates in terms of trading them and well, they're not really very active with us right now, so let's put them out for the bid, we just don't think of them that way. We did, as you'll remember, Craig, over the last 7 years, we've really streamlined our portfolio of affiliates, and we merged some, we closed some, we divested others and settled in around 9 affiliates that we feel really good about in terms of bringing unique investment capabilities and world-class investment performance. And so we're really happy with the lineup of affiliates that we have. And we don't think about trading them or selling them. It's just not the way we think about it.

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Craig William Siegenthaler, Crédit Suisse AG, Research Division - MD [25]

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And Joe, my follow-up here is on capital management. I'm just wondering is Legg Mason looking at larger transactions? So not just sort of smaller fintech D2C deals like we've seen recently but maybe something that could cost more than a couple hundred million dollars.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [26]

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Well, look, I think we look at -- there's a lot of chatter and a lot of talk. And look, a lot of other firms, a lot of CEOs are trying to figure out direction of travel and all that kind of stuff, and we do the same thing. We have a lot of conversations, and we watch some of the bigger stuff that happens out there. I would say that a bigger transaction is going to be more complicated, probably. And I think the bar is even higher. The transactions we've tended to do have been very specific, whether it be bring in infrastructure investing with RARE, bringing in non-U. S. equity with Martin Currie, solutions with QS, real estate with Clarion, et cetera. And so those have been very easy. But if you're talking like a big combination, that gets, I think, more challenging and more complicated. And I think the bar is higher for why you do that. Scale in and of itself, in our view, is not enough. Scale's important, and we're interested in building scale, and we need to continue to grow, and scale is important. But it's not enough. So we -- the bar for us would be really how does a large acquisition help us to do something together with whatever firm that would be that we couldn't otherwise do on our own? It's got to, at the end of the day, make us able to do more for our clients. It's all about the client at the end of the day. And not just about getting synergies and being more efficient and all of that kind of stuff. At the end of the day, I think that what people see is that it's got to make sense for clients, and if doesn't make sense for clients, it's not typically work -- it doesn't particularly work.

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Operator [27]

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From RBC Capital Markets, we have Kenneth Lee.

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Kenneth S. Lee, RBC Capital Markets, LLC, Research Division - Analyst [28]

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Just a follow-up one on the retail distribution and investments you're making there. Could you just elaborate on the types of investments? And related to that, should we expect increased momentum within retail as you start to realize more of the returns from these kind of investments?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [29]

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Yes. I think, look, the investments can be in terms of people, and it can be like we've done, as we mentioned, with Embark and other kind of platforms that we make investments in to reach greater -- to have greater reach. The Actinver, there's not -- it's not no cost. It's very low cost for us. But there is some investment in that outreach, in that partnership. So I would expect that as we do more -- I mentioned the Clarion Partners Fund that had we received SEC approval on. As we think about launching that, I'm guessing that we're going to be bringing in some people that are more specialized on the alternative side to support our people in the field. So we are investing in people, we are investing in technology and digital solutions, and we see -- we do see those investments pay off. We are taking market share. That -- obviously, there's an important component of that, is the investment performance that our affiliates deliver. But it's also the more holistic client experience, whether it's our marketing efforts and the collateral support and the other things that we get through marketing that we support either our people in the field or our -- the advisers that we're working with or on the insurance sub-advised space, our distribution partners there. So it's kind of the whole package. And we're seeing -- but I think the proof is in the growth of our retail business and our success there in terms of picking up share.

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Kenneth S. Lee, RBC Capital Markets, LLC, Research Division - Analyst [30]

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Great. Very helpful. And just one follow-up. On Precidian, any updated thoughts on potentially converting Legg Mason's minority interest in Precidian to a majority ownership?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [31]

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Thanks. No. We've got time for that right now, Ken. And obviously, we just want to see. There's -- we're still at an early stage here with respect to -- the approval just took place in the last quarter. And so now we've talked about the fact -- Pete mentioned the fact that we've got a significant number of licensees representing a big percentage of the addressable market. We've got another, I don't know, I think we have 11 licensees, and I think we got another 25 to 30 contracts out. And so it's building, right? But it's going to take some time. We want to see how it really plays out. We've got until -- into January of 2020 to give Precidian a notice of our intent to increase our stake. So we've got plenty of time to think about that. And once we give them notice, we then have another 9 months or so before we have to -- where we can conduct due diligence before we actually make that investment. So we're going to be thoughtful about it and do it if and when it makes sense to do so.

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Operator [32]

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From Jefferies, we have Dan Fannon.

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Daniel Thomas Fannon, Jefferies LLC, Research Division - Senior Equity Research Analyst [33]

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Just wanted to follow up on the cost plan. And maybe talk about the bucket specifically where you're getting the savings and how we should think about maybe disruptions through the business as you go through these changes. And then also Pete, could you also just highlight which line items where the charges are showing up specifically? I assume mostly comp, but if there -- if it's broken out in other areas where we could see the run rate, that would be helpful.

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [34]

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Yes. So Dan, in terms of buckets, it's -- well, first of all, one of the primary focuses here was following the Hippocratic Oath and first do no harm. So what are the things that we could do that would not be damaging to anything that we're doing with our affiliates or with distribution. And we looked a lot of soft things or sports sponsorships, some of the charitable and civic things, et cetera. And then we looked at areas where some of the things that we're doing with the affiliates coming together, like on common financial platform, et cetera, where we're going to be able to kind of safely reduce back-office functions or outsource them that we couldn't do before. And then we're taking a real hard look at kind of every spend that we have working with some of our distribution partners in terms of conferences that we sponsor and T&E, et cetera and just being very relentless around what the recurrent on investment is of each of those kind of dollars to spend. But we're -- we've, I think, at this stage, had about 70% or so of the head count that's going to be reduced, has effectively left. And so we've been operating for quite some time. All those people knew they were leaving kind of at the end of May. And we just haven't seen any real disruption at all to the business or -- kind of moving forward. And then you can actually see in the release, the -- if you go back on Page 8, has the line items where the restructuring charges are hitting. And we'll keep, again, providing a lot of detail out, Alan Magleby's been very good at making sure we understand what things you guys need, and we'll continue to provide the details we hear.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [35]

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Dan, just -- I'll just add this. I -- As I think about these costs, their -- at a high level, I think about the fact that we -- I challenge the teams to think about what we can just stop doing. I've also asked the teams to think about what it is that we can do differently or have someone else do it. It's kind of simple stuff in real terms. And you'd be surprised how many -- when you really push people, how much you can learn what you just can actually stop doing and with a focus, as Pete said, on not touching clients and not really impacting the affiliates, and we've been able to do that, I think.

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [36]

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Hey, Dan, one other thing to add. The things that are in the release are the historical, but looking forward, the $20 million that we talk about on Slide 12 in next quarter on the costs to achieve, the way those break out right now. And again, I don't know as to the exact position, but comp and benefits, we have, $13 million, Communications & Technology at $1 million and then Other roughly at $6 million. And again, could be some moving around in terms of rounding, but that should get you there.

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Operator [37]

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From Bank of America, we have Mike Carrier.

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Michael Roger Carrier, BofA Merrill Lynch, Research Division - Director [38]

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Maybe just given some of the equity outflows versus the fixed income and the alt inflows you guys are showing and then looks like the pipeline was kind of in the same direction. Just any color on maybe some of the key products that are just driving your weakness or strength. And then given the mix that you're seeing, like how should we be thinking about the fee rate going forward?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [39]

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Well, look, I think, as I mentioned on the positive side, we've been winning. We took, I think, meaningful share on the retail side of the business. In the retail channel, we took meaningful share in fixed income, particularly in core and core plus strategies and more traditional strategies there. And on the alternative side, a significant -- another significant quarter for Clarion, which is just -- and now we're starting to see EnTrust capture some nice flows as well. On the challenge side, I would say on the equity side, in particular, I think you've seen some of the strategies, larger strategies, aggressive growth that ClearBridge has been challenged. Some of the -- we've actually -- the interesting thing about that, and this is where I think ClearBridge has done such a good job, we talk about diversification, Terrence Murphy and his team there have diversified their business significantly. I think they've got inflows going in 7 different strategies to a degree in -- at ClearBridge, but they also have some outflows that they've been experiencing in the aggressive growth strategy. So Martin Currie, we expect to see their emerging markets strategy pick up. We know they have a nice unfunded win coming in, in that strategy. And as I mentioned, we're getting flows on the positive side there in retail as well. So I think it's in some of the -- it's really -- a lot of it's just performance-driven, and I think the challenges in equities, we still had some challenges at Royce, although there, Royce is picking up some nice flows, particularly in Japan right now in a global growth strategy -- global small-cap growth strategy there. So it's mixed. I mean we've got an awful lot of products out there, and I think we have a lot of products that are flowing but a couple of big ones on the -- one big one in particular on the equity side at ClearBridge that's been a little bit challenged.

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [40]

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And on the yield side, Michael, the -- we kind of see ourselves hanging around in this 36, 37 basis point ZIP Code. Just keep in mind, we're slicing the salami pretty thin when we get out there, but we're very much in rounding land where just a slight tick up or slight tick down grounds us one way or the other. But overall, we're not immune to the pricing pressures, but we've been pretty happy around how we've been able to hold serve and kind of see that a little bit equally balanced. So we're not immune to the pricing pressures, particularly in legacy businesses and products but a lot of what we're doing around expanding client choice, a lot of what you're seeing with the new products at Clarion, with what the EnTrust guys are doing, et cetera, all [and] higher fee things. So we're feeling reasonably confident to be able to stay in the same ZIP code that we're in right now on the revenue yield.

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Operator [41]

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From Evercore, we have John Dunn.

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John Joseph Dunn, Evercore ISI Institutional Equities, Research Division - Associate [42]

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Just a quickie for me. There seems to be a growing level of concern about -- for investors about people's energy exposure. So can you just remind us on the equity and fixed income side where you guys play?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [43]

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I'm sorry, on the energy side?

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John Joseph Dunn, Evercore ISI Institutional Equities, Research Division - Associate [44]

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Yes. Your energy exposure, both on a equity and fixed income sides to the extent you have it?

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Peter Hamilton Nachtwey, Legg Mason, Inc. - CFO & Senior EVP [45]

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Yes. Actually -- well, this is Pete. So we have a risk management group. It has a number of folks that look at the investment side of things and look at exposures by industry. They look at specific issuers, et cetera. And right now, nobody's feeling like we're overweight in any of our asset classes in terms of the energy space.

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Operator [46]

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And we have time for one more question. And from Morgan Stanley, we have Michael Cyprys.

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Michael J. Cyprys, Morgan Stanley, Research Division - Executive Director and Senior Research Analyst [47]

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Just a question on the existing digital platforms that you have with Quantifeed and Financial Guard. Just curious if you could update on those initiatives, how that's tracking relative to what you expected when you had announced the deals a couple of years ago and where they stand today in terms of assets?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [48]

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Quantifeed is barely a year old for us. So that's -- I would say, the level of interest that we're getting from some global partners is actually significant. We've seen interest from global partners in Japan, we've seen some from -- in Australia, I believe, there -- and then certainly throughout Asia. I think it's got some real potential. But who knows, we'll see. We'll see what the uptake is from clients. And again, here we are, in this particular case, marketing specifically with our investment through Cathay but also other partners that may want to utilize that digital technology. With Financial Guard, Financial Guard is the engine that we use to support a significant -- well, support a significant piece of business that we have with a 529 plan. And that will be the engine behind really that direct access. We do business with a 529 plan, but that is now expanding into the digital space, and that will be the engine behind that. And then Embark, I think is, again, really an opportunity there. Obviously, it's only a month or 2 old. We've actually had an inquiry about that, that could generate something out of the gate. But I would say the flows are not significant at this point, but they're positioned well. And to the extent that the investor starts moving in and doing more and more with using digital platforms, I think we've got 3 here, 1 in the U.S. And I think the one, Financial Guard in the U.S., we can use that to extend potentially beyond just the 529 plan that we have. I think we've got a good one in Asia with Quantifeed, and I think I'm excited about Embark. So these are early stage things. But we're excited about them.

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Michael J. Cyprys, Morgan Stanley, Research Division - Executive Director and Senior Research Analyst [49]

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And as you think about these new distribution relationships that you announced in Mexico and the U.K., I guess what does success look like in 3 to 5 years? And what sort of lessons learned do you take from prior strategic relationships or JVs that you had?

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [50]

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Look, I think this partnership concept is one that's just expanding and increasing, right? You keep hearing about clients wanting to do business with fewer partners. And it's just true. I mean we're hearing it from our largest distributor clients around the world that they're going to continue to shrink the number of firms, and they want firms that have a breadth of capabilities, they want firms that have a breadth of vehicles, they want firms that have people around the world that can help support them. And so I think it can be a very cost-effective way to expand our distribution. I mean we can't be in every country with a brick-and-mortar office and sales force. It's just not a cost-effective and realistic approach for us. And to build brands outside of the U.S. takes a long, long time. So for us to access the Mexican market through Actinver rather than trying to build a Legg Mason brand, I mean that just -- the chances of that being successful faster are much greater. And that's what we're doing, and that's why when we can access with a global private bank and use their sales force and their brand, maybe for a bit of a lower fee, we may have to split that, but the likelihood of success is just much greater. So where we think we can make a huge difference and where we think our brand works, and we have a lot of those around the world, whether it be Japan or whether it be Australia, whether it be various places on the continent of Europe or in the U.S., yes, great. But we're not, we look for partners. And so that's how we think about it.

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Operator [51]

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Thank you, and that concludes our question-and-answer session. I will now turn the floor back over to Mr. Sullivan for our closing comments.

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Joseph A. Sullivan, Legg Mason, Inc. - Chairman, President & CEO [52]

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Brandon, thank you, and thanks to all of you for joining us this evening. I am pleased with the progress at Legg Mason on a number of fronts, be it creating a much more efficient cost structure, investing in the business for growth, innovating new investment and service solutions for clients or continuing to evolve our governance structure with new and diverse Board Directors. Our affiliate and Legg Mason colleagues are passionate, and they're focused on our clients. And together, we are building a better Legg Mason. So thank you for your interest, and I look forward to updating you on our progress again next quarter. But for now, have a nice evening.

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Operator [53]

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And this concludes today's conference call. Thank you for your participation. You may now disconnect your lines at this time.