ANTICIPATING CLIENT NEEDS, OFFERING MODERNIZED BUILDING BLOCKS AND DEVELOPING NEW SOLUTIONS

P E R S P E C T I V E S

Q: How are client needs evolving?

A: It is getting harder for investors to achieve their goals in this very complex and complicated world. These challenges are changing how we and other investment firms deliver products and services. Simply offering clients many choices is insufficient; we must help them navigate the landscape, create solutions and curate their investment experience according to their preferences. How do they want to engage with their finances and portfolios?

Q. Is the investment management industry being disrupted in similar ways to consumer industries such as retail, taxi services, hotels, media and others?

A: Disruption can be viewed two ways. One is as a headwind for asset managers like Legg Mason, against the ways the industry has traditionally operated. But it can also bring opportunity; Legg Mason must adapt and evolve alongside our clients, and provide the services that will help them meet tomorrow’s challenges. Disruption is real; strong forces are driving it.

Todd Barmash Product Strategy

Jaspal Sagger Product Strategy

Todd Barmash and Jaspal Sagger of Legg Mason’s Product Strategy team discuss how Legg Mason is innovating to meet the evolving needs of clients now.

Q. Can you talk a little more about this disruption? What forces are driving it?

A: The forces influencing evolving client needs can be broken down into three main areas: the new economic reality; societal changes; and the technology revolution.

Under the new economic reality, forces include low economic global growth, the low (and even negative!) interest rate policy from central bankers around the globe, and market volatility resulting from heightened geopolitical risks. This has created an environment that could provide lower nominal returns than in recent boom years.

The second piece of disruption is societal and demographic changes: aging societies in developed markets; the rise of millennials and younger populations around the world; increasing globalization; the huge growth of emerging market middle classes; and socio-environmental awareness of retail investors. In the U.S., defined benefit retirement savings plans are changing to defined contribution.

The third major disruptor is technology. Most investors -- not just the common misperception of the millennials -- are used to a world that is fully digital, mobile, customized and … cheap. Clients expect the Amazon experience. Simplicity and customization drive how investment management services are being delivered, highly tailored in a multiplicity of wrappers or access points.

Fee pressures necessitate greater transparency. Investors are questioning their returns from traditional investments and making greater use of passive. There has been a move from commission-based distribution to fee-based. That means the value of the investment becomes much more important to the financial adviser making the sale.

Q: In this rapidly shifting environment, how do Legg Mason’s products evolve?

A: Client needs across the globe are generally universal – income generation, growth, preservation of savings. But regional buying preferences, regulations and other factors all influence how investors access investments to meet these goals. Each investor needs a customized mix of investments. Legg Mason is laser-focused on growing a diversified range of products suitable for customized client portfolios and investment solutions.

Innovation requires that we understand how clients build their portfolios. We add value by working with financial advisers to really understanding how our investment products can be used as building blocks to larger solutions.

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We continually innovate the product set with initiatives that meet immediate and near-term needs until fruition and mass appeal, as well as others that have longer horizons..

That’s the benefit of having nine specialist investment managers: our affiliates provide clients access to world-class investment expertise across multiple asset classes and strategies. And we can deliver these strategies in the wrapper or vehicle that best suits their needs.

Q: If the product set is constantly expanding, can it become too diversified?

A: We must ensure that existing products have good lifecycle management processes, so they remain relevant. If not, then we must reinvigorate failing products through changes in pricing or repositioning, potentially merging and closing some down. Our starting point is always to ensure that we have the best possible foundation to meet our clients’ requirements.

Q. What key themes come out of all the economic, demographic and technological changes?

A: There are several, including increases in:

• Goals-based investing

• The greater need for income in aging populations

• Calls for diversifiers to mitigate global volatility

• Demand for ESG analysis and values-based investing

• The importance of tax efficiency and lower cost investments to maximize returns in a low-growth world.

• Access to investments in a fully digital world

Q: What do you mean by “goals-based investing?”

A:Investors have long measured success as product or portfolio performance relative to traditional measures, whether benchmarks or peer groups. “What is the maximum return that can be attained at the desired level of risk?” Risk being defined as fluctuations in the portfolio’s value.

Goals-based investing completely shifts the paradigm and redefines objectives and risk. The goal is no longer “maximum return.” Instead, goals are defined very specifically: accumulating enough wealth to

pay for a four-year private university in the U.S., generating £2,000 a month in income for a UK retiree, seeking a 5% annual return for a cash balance plan, hedging dollar inflation, or bequeathing a ¥110,000,000 inheritance to heirs. There are endless possibilities.

The emphasis has shifted to how we can work with clients to realize their investment, life and business goals. Risk is defined as the probability of not achieving the goal, and progress is tracked in those terms. All of this helps shift the conversation towards customized portfolios and away from comparisons to simple market cap indices.

Q. How can you generate income for investors across so many global markets?

A: A prime example of goals-based investing, there are endless ways of delivering income. What matters most is meeting longevity risk: the fear that investors will outlive their money. Investors need income to facilitate expenditures over their lifetimes.

How we provide income products depends on the targets and risk budgets of our clients. It could be through packaged solutions, such as multi-asset income products, or equities, or fixed income, or even by specific features such as income-paying share classes within traditional mutual funds.

In today’s low interest rate environment, investors have been forced to reach further for yield. In regions where appetites for income have always been high, traditional strategies and asset classes may no longer satisfy. “One-size-fits-all” worked in the past, but disparate regions and markets increasingly require novel types of solutions. Asset managers must innovate relentlessly to meet these challenges.

Many investors prefer the security of assets with a certainty of risk. Because some asset classes deliver natural income, investors can consider them as risk-averse ways of receiving income. This often appeals to investors who are concerned about growing market volatility. For example, fixed maturity bond products have been launched in Asia, offering more certainty of the income by holding portfolios for specific time horizons. Risk-averse investors can invest in equities that deliver income as a good proportion of their potential type of return.

Q: It’s impossible to ignore the extent to which investors have gravitated to passive investing over the past decade. What do you see as the role of passive investing, and will it continue to grow?

A:Passive completely has a role to play, especially in managing a portfolio’s core cost budget; we believe there will always be value in having some combination of active and passive exposures.

Passive, or indexed, investing has fundamentally changed investors’ expectations of the cost of investment products. Facilitated by global regulations that mandate fee transparency, it has also changed the way investors think about the value provided by active managers. It has highlighted the importance of active managers being truly active, raising the bar beyond results that can be inexpensively obtained via indexing.

Overall costs of active investments have decreased as passive investments have been commoditized and come under fee pressure. Thus, delivering active investments at lower cost is critical to a well-diversified product line-up.

P E R S P E C T I V E S

Q: How has passive investing evolved over time?

A: Aside from the very visible and precipitous decline in fees (in fact, firms recently introduced the first zero-fee ETFs in the U.S.), investors are beginning to increase usage of factor-based indexes and ETFs.

Passive developed around one approach, market cap-weighted indices, which tends to overweight stocks that have been most successful, not those with the greatest potential. Factor indexes instead seek to isolate and replicate intrinsic exposures in the market – such as size, style, quality, etc. – that drive market returns. Combining market-cap weighted indexes with factor-based investments may help to deliver the outcomes and diversification clients want.

Q: How is Environmental, Social Responsibility and Governance (ESG) analysis incorporated into the Legg Mason product set?

A: The great variety of ESG investment preferences is evolving at different rates globally. There can be a broad range of client motivations in values-based investing, and itis important to understand the specific motivations of each client. Are they looking solely for performance or risk management benefits from ESG analysis? If so, they may want asset managers that simply incorporate ESG analysis into their products and investment processes.

Some regions, such as certain European countries, are making ESG analysis a prerequisite for virtually any investment. Many knowledgeable investors, especially in the developed world, believe companies with strong ESG practices are better managed and governed, and likely to outperform companies without those qualities. In other areas, such as emerging markets, ESG analysis has gained little traction.

Investors may seek thematic exposures to certain sustainability, governance or environmental issues. Others simply want to exclude particular industries – weapons, extraction, tobacco – under values-based judgments. Still others seek to influence ESG policy at individual companies. These investors should look for managers that actively engage with companies and corporations to change their policies.

As for differences among markets, ESG investing is well established in Europe and the U.S. Australia and the U.K. have larger ESG focuses than Asia, which with its younger population, is more focused around return, yield and income. If ESG analysis proves to Asian investors that it can deliver better outcomes, they likely will pursue it. Until then, it will exemplify how the motivations for investors in diverse locations can differ.

Q: What sort of diversifiers are clients increasingly looking for?

A: Real assets, infrastructure, commercial real estate and private debt are solid diversifying asset classes. Long-short and absolute return strategies rely on uncorrelated manager returns to provide diversification. Less liquid products may also offer diversification properties.

Q: How are clients changing the way they access investment capabilities through vehicle types?

A: Newer product vehicles, or existing vehicles that have seen operational or other improvements, are driving significant change. This trend is most evolved in the U.S. For many years, the ‘40 Act mutual fund was the all-purpose vehicle used to address multiple market segments and investor types – retail, high net worth, retirement. With the advent of exchange traded funds (ETFs), collective investment trusts (CITs) and separately managed accounts (SMAs), investors can select the vehicles most able to achieve their precise goals.

Vehicle choice can be a product of anything: investor tax situations, wealth levels, operational platforms, liquidity needs, and many others. It is important for us to remain vehicle-agnostic, so where appropriate we can offer investment strategies in as many wrappers as possible. We want to have vehicle types available for whatever need our clients have.

We can also help curate their choices; asset classes can be more effective in some vehicle types than others. Commercial real estate is an example, since it is too illiquid to be offered in an ETF.

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Q: How has technology and the digital environment changed the way you work with clients?

A: The advice model is evolving. Digital distribution is going more mainstream. Regulatory and technological change are driving the growth of customized outcomes (goals-based investing that is more multi-asset) and greater use of lower cost vehicles.

Technology is a tool, an enabler to the client experience and the client journey. When used properly, it is additive to the investment process. Today’s technology is powerful enough to offer truly customized solutions for individual clients. We can create investment products that easily fit into highly customized asset allocation models and provide asset allocation guidance to financial advisers. When we can help advisers visualize progress to investor goals via technology, it enhances the overall experience. We can offer wider ranging investment services in a technology-based world.

As for financial advisers, one of their biggest challenges is the increasing cost of advice: providing clients with statements, reports and regulatory requirements, let alone meeting face-to-face. Technology can help advisers service clients efficiently to create customized outcomes. It can enable clients to see every day where they are relative to their investment goals and what they may need to change. Technology should continue to enhance the ability of financial advisers to lower the costs of onboarding, servicing and ultimately retaining clients.

Q: How do you generate Legg Mason’s product development ideas?

A: Good investment ideas can – and should – come from anywhere, all the way across the value chain, from challenges our clients face today to those we anticipate. It is an evolving landscape.

At Legg Mason, we are in an enviable position because we can get fantastic ideas, leveraging the investment expertise of nine investment affiliates as well as our global geographical reach, so ideas in one location can often become relevant in other locations. We can quickly and cost-efficiently package these ideas into local funds, cross-border funds and other vehicle options.

Our most successful investment ideas have generated from working directly with clients to develop the products and solutions they want and need. To facilitate product development, we try to get close to our clients, our big clients, our key strategic partner firms, in many locations.

What is equally important is that Legg Mason has a strategic product agenda. It is about understanding what the secular drivers of structural demand could be in the future. As an example, we think a lot about retirement: where and how is it evolving, what solutions do investors need, how can technology help, and what types of new products may investors demand.

We try to think ahead and have a good perspective around the things we can anticipate. It helps us evaluate the investment platform we have, how to build on it, and how we can acquire or organically build new investment capabilities to meet current and future challenges.

To this end, our affiliate QS Investors, an institutional-caliber asset allocator and solutions provider, is highly skilled at generating ideas that can fill gaps in the Legg Mason product lineup. In fact, many of our best product development ideas come up from our affiliates, usually because of suggestions and requests from institutional clients. It is a highly collaborative process.

Q: How do you bring these efforts all together into a global product set?

A: Legg Mason’s business model relies on having a diversified investment platform that covers a wide range of asset classes, investment approaches and investment strategies. In product development, our first job is to make sure that we have a product set that continues to meet the needs of our clients. Robust product lifecycle management ensures that our products are still appropriate and relevant for what they were originally intended for, that they are priced appropriately, and they are available and positioned correctly in the geographies and locations where we want to operate.

There are many drivers when it comes to launching new products. The most important by far is an involved client asking for something customized that can deliver a specific outcome. We look for ideas that will strategically fit our existing set and provide opportunities that will continue to be relevant for clients. Having anchor investors who can give us input and feedback greatly helps us deliver innovative, top-quality commercial products.

We also generate interesting propositions that clients might not necessarily realize they are trying to solve for today but may meet future needs. We try to understand the drivers of disruption in the marketplace and anticipate demand, to be tactical and strategic in our product development.

We believe these guiding principles will help us generate a diversified portfolio of building blocks that be used to create more effective bespoke outcomes for advisors and their clients.

P E R S P E C T I V E S

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