A surge of investor redemptions has slashed the size of Western Asset Management Co.'s flagship core plus bond mutual fund below $10 billion, with the bulk of the outflows coming amid a federal investigation of the firm's veteran trader and Co-Chief Investment Officer Ken Leech.

Uncovering the Fallout from Western Asset Management's Woes

Shrinking Assets and Dwindling Confidence

Clients have been yanking their cash since the Pasadena, California-based company said on Aug. 21 that Leech was going on leave after he received a notice from the US Securities and Exchange Commission that it may recommend enforcement action. The core plus fund's assets have shrunk to $9.96 billion as of Nov. 1, from $22.3 billion to start 2024 — representing a decline of more than half this year, according to data compiled by Bloomberg. This dramatic reduction in assets under management has sent shockwaves through the industry, as investors lose confidence in Western Asset Management's ability to navigate the turbulent market conditions.

Earnings Miss and Analyst Concerns

Franklin Resources Inc., which owns Wamco, on Monday reported adjusted earnings per share for the fourth quarter that missed the average analyst estimate. Analysts at Evercore ISI, led by Glenn Schorr, noted that there's "no way to sugar coat or diminish the adverse impact Western is and will continue to have on" Franklin Resources. However, they also pointed to "multiple positive trends that should lead to growth and a more diversified Franklin in the end."

Record-Breaking Redemptions and Shrinking AUM

Wamco said investors redeemed $27.9 billion from the firm overall in September, according to an Oct. 9 filing. Wamco's assets under management fell to $353.3 billion as of Sept. 30 compared with $376.8 billion a month earlier. The three-month period ending Sept. 30 was the worst period of redemptions on record for Franklin, according to data since 2007 that was compiled by Bloomberg.

Flagship Fund's Woes and Underperformance

The outflows have been especially visible in the Western Asset Core Plus Bond Fund, which recorded a net outflow of $8.18 billion in the third quarter, bringing its year-to-date decline in assets to $11.1 billion, according to Morningstar Direct. Wamco's Core Bond mutual fund, meantime, saw a net outflow in the three months ending in September of $6 billion. As the pace of the outflows from Core Plus accelerated, the fund has been selling existing holdings. The fund has also severely lagged peers, ranking in the bottom rungs over the last three- and five-year periods as well as so far this year, the data show.

Leech's Departure and the SEC Investigation

A spokesperson for Western Asset Management declined to comment on the ongoing investigation by the Justice Department, which is looking into whether Leech parceled out winning trades to favored clients at the expense of others — a practice known as cherry-picking. The departure of Leech, the firm's veteran trader and Co-Chief Investment Officer, has further eroded investor confidence in the company's ability to navigate the challenging market environment.

Significant Client Withdrawals and Relationship Terminations

Among some of the bigger investors that have said they are leaving Western Asset are the Ohio Bureau of Workers' Compensation, which decided to pull roughly $750 million, and the Chicago Teachers' Pension Fund, which had roughly $550 million with the firm and is ending its relationship. These high-profile client withdrawals have only exacerbated the firm's woes, as it struggles to retain assets and maintain its reputation in the industry.

Wamco's Struggles and the Impact on Franklin Resources

Wamco has been hammered by consistent outflows for its flagship fund over nearly three years after a recent peak around $42.3 billion in August 2021. Under the leadership of Leech, the firm's bond strategies reflected a view that Federal Reserve rate hikes from 2022 would be measured and not drive Treasury bond yields to last year's peaks of 5%. However, this view has proven to be misguided, as the Fed's aggressive rate hikes have had a significant impact on the performance of Wamco's core plus bond fund, further eroding investor confidence and leading to the massive outflows.