Legg Mason Sees No Growth at Permal in Next Two Years But Lots at Entrust

By Hedge Fund Insight staff

Yesterday’s release of the 10-Q filing of Legg Mason, parent of fund-of- funds group Permal, contained an update on the parent’s expectations of growth at the hedge fund subsidiary.  Expectations have been lowered, leaving the carrying value of the business at less than half of that previously held in LM’s books.

This is an extract from the 10-Q:


“The Permal/Fauchier funds-of-hedge funds contracts of $698 million accounted for approximately 20% of our indefinite-life intangible assets, and are supported by the combined funds-of-hedge funds business. These funds have continued to experience periods of moderate inflows or outflows over recent years and certain increased risks, as follows. The past several years have seen declines in the traditional high net worth client funds-of-hedge funds business, Permal’s historical focus, which Permal has offset to some extent with inflows in their institutional business. Further, funds-of-hedge fund managers are subject to certain market influences, as evidenced in Permal’s growth in institutional funds and separate accounts, adding additional uncertainty to our estimates. Due in part to these factors, actual results for the 12 months ended December 31, 2015, generally compare unfavorably to growth assumptions for the Permal funds-of-hedge funds contracts used in the asset impairment testing at December 31, 2014. Additionally, the Fauchier business is now subject to risk associated with the anticipated loss of certain key staff. As a result, in our December 2015 testing, the growth assumptions for these contracts were reduced in the first five years, which, together with the impact of decreased margins in the first two years, led to decreased projected cash flows from the business. Also, the projected cash flows from the Permal/Fauchier funds-of-hedge funds contracts were discounted at 16.5%, compared to 14.5% used in the prior year’s impairment testing, reflecting the factors noted above.
Based upon our projected discounted cash flow analyses, the carrying value of the Permal/Fauchier funds-of-hedge funds contracts asset exceeded its fair value of $335 million, resulting in an impairment charge of $364 million for the excess. Cash flows on the Permal funds-of-hedge funds contracts are assumed to have an average annual growth rate of approximately 7% (5% market and 2% organic/other). However, given current experience, projected near-year cash flows reflect moderate AUM outflows in years one and two, no net AUM flows in year three, and trend to modest AUM inflows in year four. Investment performance, including its expected impact on future asset flows, is a significant factor in our growth projections for the Permal/Fauchier funds-of-hedge funds contracts. Our market performance projections are supported by the fact that the two largest funds that comprise approximately half of the contracts asset AUM, have 10-year average returns approximating 5%. Our market projections are further supported by industry statistics.”


As a result of the new (no) growth expectations the book value of Permal in the accounts of Legg Mason, as far as Indefinite-Life Intangible Assets are concerned, has been reduced from $698m to $335m – a loss of value of $364m.
On the 22nd January this year Legg Mason announced that it has agreed to merge its Permal hedge fund platform with alternative asset manager EnTrust. Joseph Sullivan, chairman and CEO of Legg Mason, said at the time “The combined EnTrustPermal brings together two leading names in the alternative space, creating a significant potential growth engine for Legg Mason.” Given the change to expectations for growth at Permal in the 10-Q the significant potential growth must be down to EnTrust.


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