Franklin Templeton is battling the worst quarter for outflows in its history, as reputational damage and poor returns spurred tens of billions of dollars of withdrawals from its fixed-income business just as rivals are being boosted by falling interest rates.
The group, which manages $1.7tn in assets, announced in August that the co-chief investment officer of its largest subsidiary had been put on leave amid a probe by the Securities and Exchange Commission.
The news has compounded investor concerns about years of underperformance and prompted a flood of outflows from big clients just as many institutions were looking to increase fixed-income allocations.
“This is all happening while there’s a lot of money in motion in fixed income,” said Alex Blostein, an analyst at Goldman Sachs.
With about one-third of its assets in fixed income, Franklin was expected to be one of the largest beneficiaries from the move into bonds funds as the Federal Reserve lowers interest rates.
“They’re totally going to lose out on that now, because of poor performance and the reputational risk . . . it makes it very difficult for anyone to allocate new capital to them,” Blostein said.
More than $37bn left Western Asset Management, the subsidiary at the centre of the concerns, in the past three months, with almost $24bn of outflows in September alone. Franklin’s net outflows are expected to be at least $31bn in the quarter that ended September 30, the worst in its history.
Rivals such as Pimco, Invesco, Guggenheim, BlackRock and JPMorgan have all reported strong flows into fixed income over the past quarter, noting that “money is in motion” back to those products after years of caution caused by higher central bank rates.
The SEC and Department of Justice are investigating Western’s derivatives trades for wealthy customers. Co-chief investment officer Ken Leech was put on leave after receiving an SEC “Wells notice” for allegedly “cherry-picking” client trades, the practice of giving more profitable trades to some clients over others. A Wells notice is a formal document that is often, but not always, followed by enforcement action.
The announcement that the SEC was investigating Leech’s derivatives trades over a three-year period prompted a 13 per cent drop in Franklin’s stock as investors reckoned with the potential impact on earnings. Almost $8bn flowed out of the manager in the space of a week, and Western closed its Macro Opportunities strategy, which had about $2bn under management at the end of July.
Problems with Western’s business have been simmering for some time. The core fixed-income manager performed near the bottom of its class in 2023 and 2022 after betting that inflation would be shortlived. Firms, frustrated with years or poor performance but afraid of burning a long-term relationship, saw an opening.
“Legal trouble can be a really good guise for getting out of a [underperforming] fund,” said one pension fund manager. “We were able to get out with our nose clean.”
The pace of outflows is expected to accelerate. While smaller investors are able to withdraw their funds quickly, large investors such as state pension funds have formal processes for reallocating capital, which could take time to show up in Franklin’s numbers.
Western is one of the most prominent core bond managers, the most competitive segment of the bond market. This means firms are often competing not just for new capital, but funds from competitors. Another large asset manager said they were putting together new business pitches requested by some of Western’s investors, who are in the process of finding new fixed-income managers.
“Whenever you get into these existential [regulatory] issues, many institutions have no patience for that. Many have a fiduciary duty to pull the money from the manager,” Blostein added.
Western was one of the largest assets Franklin gained when it bought Legg Mason in 2020, part of a number of mergers and acquisitions by the company to regain relevancy in a rapidly transforming industry.
The $4.5 acquisition doubled Franklin’s assets under management to $1.4tn, making it one of the biggest fund companies in the world. Western’s strong reputation as a fixed income house was a boon to Franklin, which had struggled with organic growth and suffered when poor performance whittled its flagship bond fund down from $70bn in 2014 to less than $15bn in the US by 2020.
At the time of the August announcement Western had about $380bn under management, representing about 10 per cent of Franklin’s total revenues.
A five-year independence agreement from the acquisition meant that Western maintained its autonomy. Western had a reputation as one of the most difficult franchises within Franklin to manage, calling into question the strength of its oversight of its subsidiary.
“If the controls are weak enough that this guy can do a cherry-picking exercise and favour certain clients over others, how could you, as an investor, stay there when you’re not even getting good performance,” said Brennan Hawken, an analyst at UBS.
Western had bouts of strong performance in large part because of Leech’s bold interest rate bets.
“That was our reputation, it was high beta,” said one former staffer.
But big, risky positions had a downside, and staffers noted that poor performance had been a looming threat to flows long before Leech’s departure: the firm floundered during the financial crisis and after the pandemic. Western has not seen a positive quarter for flows since November 2021.
“The risk profile [of the Western strategy] was not a good match for the fund’s objectives, exhibiting more downside and higher volatility than we would have liked,” said Bill Harding, chief investment officer at Jackson National Asset Management, which fired Western as a co-adviser on a fund last year.
Departures have accelerated since the August announcement. The Dallas Employees’ Retirement Fund, Chicago Teachers’ Pension Fund and Ohio Bureau of Workers’ Compensation, among others, have announced they are to leave Western. It also lost its role as a sub adviser to two funds at Russell Investment Management, and SEI.
Franklin Templeton declined to comment.
Staff bonuses are determined in November based on the firm’s revenue share with Franklin, meaning big hits to its bottom line could have an outsized impact on staff. Western’s independence clause with Franklin is also coming to an end early next year.
“Western is toast,” said Hawken at UBS. “There’s no question [Franklin] has buyer’s remorse. But there’s nothing they can do about it.”
Additional reporting by Sun Yu, Brooke Masters and Will Schmitt
