Smith Barney’s claims to open architecture made more persuasive. Legg Mason’s acquisitions of Citigroup’s asset-management unit and fund-of-hedge-fund manager Permal complete its transition into a pure-play money manager – one of the biggest out there. From a wealth-management perspective, the deals broaden Legg Mason’s private-client offerings – especially in the areas of separately managed accounts (SMAs) and alternatives – and, for a period at least, greatly enhance its distribution capabilities. Meanwhile, Citigroup’s wealth-management entities, including its Smith Barney brokerage unit, stand to benefit as the absence of a big investment-management affiliate underlines their adherence to a policy of open architecture.

“The whole thing is amazing,” says Elizabeth Nesvold, a managing director of New York-based investment bank Berkshire Capital, which advised Permal’s management team on its deal with Legg Mason. “No one will ever again think of [Legg Mason] as a regional broker-dealer.” As for Citigroup’s wealth-management business, losing its asset-management arm “takes away some the confusion by allowing it to make its investment consulting the focus” of discussions with clients – not the degree to which it does or doesn’t recommend proprietary investment products.

Writ large

The terms of the transactions are pretty well known. By the end of this year Baltimore-based Legg Mason will have handed over its brokerage business and about $1.5 billion in stock – a 14.4% stake – in exchange for most of Citigroup Asset Management (CAM) and a three-year distribution agreement. The deal excludes all of CAM’s Mexican business, its Latin American retirement services and its interest in CitiStreet, a benefit-plan provider owned jointly by Citigroup and State Street Corp. Those businesses aside, CAM has about $437 billion in assets under management, putting Legg Mason’s after-deal total at around $830 billion, according to the companies’ latest March-quarter reports.

In a separate deal, Legg Mason will pay Paris-based Sequana Capital, formerly Worms & Cie, about $800 million for 80% of Permal, with the right to buy the rest over four years. London- and Paris-Based Permal does all its business outside the U.S., notes Legg Mason CEO Raymond “Chip” Mason – something his company is eager to change. Permal’s management team has a 23% stake in the firm.

The CAM acquisition will make Legg Mason the fifth-biggest money manager in the U.S.; its subsidiary Western Asset will become the biggest “pure” fixed-income manager in the world. Permal is already the world’s fifth-biggest fund-of-hedge-fund manager. “These acquisitions fit our long-term strategic objectives of maintaining balance and diversification,” says Mason. “We get a broader set of investment teams that get strong results and [have] strong capabilities in areas we didn’t have before” – specifically fixed income and hedge funds of funds. The CAM transaction also enhances Legg Mason’s large-cap growth and core fund offerings, complementing its “existing strength across [the] value, blend and small-cap asset classes,” according to a Legg Mason press release. In addition, Legg Mason will become the biggest retail SMA manager with the addition of CAM’s roughly $58 billion in client assets.

Both sides

“The business swap with Citigroup should benefit both companies,” says Mason. “We expect to more than double our assets under management, broaden our geographical reach into critical global markets and, through a three-year global distribution agreement, significantly expand our ability to distribute our retail money-management products around the world through a financial powerhouse.”

The distribution agreement, under which Citigroup will sell ex-CAM products as well as Legg Mason Wood Walker equity funds for three years after the deal goes through, could be big for Legg Mason. With its 127-office, 1,354-strong intermediary force joining Smith Barney’s 500-office, 12,100-broker distribution network, Legg Mason gets a nationwide sales force to front its investment offerings – “subject to [the] usual suitability and performance standards,” Citigroup underlines in a press release. Abroad, the agreement gives Legg Mason access to lucrative markets in Europe and the Asian-Pacific region. Right now Legg Mason does most of its business in the U.S., Canada and the U.K. The distribution deal extends to the Citigroup Private Bank, Primerica and Citibank intermediary networks as well as Smith Barney.

Citigroup sees the business swap with Legg Mason as an opportunity to improve private-client services. “We have been assessing our options for the asset management business and have found in Legg Mason a partner with an excellent product set that complements and enhances our existing product offering to our customers,” CEO Charles Prince says in a press release. He adds that Citigroup welcomes Legg Mason’s “high-quality team of financial professionals” to its wealth management business. “Deepening our relationships with clients is a top priority,” he says. “Through this transaction, we are even better positioned to meet their investment needs.”

Seeming and being

Frank Campanale, a wealth-industry strategist and former head of the “Consulting Group,” Smith Barney’s fee-based private-client platform, thinks the deal gives Legg Mason and Citigroup some much-needed clarity. “Asset management should be completely separate from fee-based consulting,” he says. “With this transaction Legg Mason becomes a huge asset-management concern with all the conceivable styles.” The deal also makes the Consulting Group “look pretty good,” he adds. Despite Smith Barney’s pioneering efforts in open architecture, Campanale says the existence of an affiliate asset manager fostered a “perception of conflict.”

In its purest form “open architecture” refers to an investment advisory’s policy of having no proprietary products on offer. It’s also used – along with the term “enhanced architecture” – to describe a policy of putting proprietary and non-proprietary offerings on an equal footing. Some say open architecture is vital to ensuring that advisors serve their clients’ – rather than their firms’ – best interests.

Paul Fullerton, an analyst who tracks the fee-based advisory business for Cerulli Associates, a Boston-based research firm, agrees with Campanale. “The fact that Citigroup is getting out of asset management gives Smith Barney a more purely objective stance,” he says.

Makes sense

Jamie Waller, an SMA-operations consultant (and CEO of this publication), adds another perspective: the Legg Mason deal plays to Citigroup’s comparative strength as a wealth manager. “Asset management is a good business,” he says. “It’s fairly stable and not very capital intensive” compared with other financial-service functions. CAM, however, is “simply not that material to Citigroup,” says Waller, a co-founder of Security APL, now CheckFree Investment Services, and a former CAM executive. “Certainly not compared with banking and other areas, including wealth management.”

A glance at the Citigroup’s numbers bears that out. Last year CAM saw a net income of $231 million. That’s roughly 1.4% of Citigroup’s $17-billion total net income for 2004. Meanwhile, its “Global Wealth Management” division – Smith Barney along with Citigroup Private Bank – brought in $1.2 billion, or about 7% of Citigroup’s overall net income; a result undermined by Citigroup Private Bank’s troubles in Japan. The company’s consumer-oriented credit, financing and banking businesses bought in about 70% of its net income last year.

There’s yet another point in favor of Citigroup’s move to sell its asset management business, says Campanale. “We’re now at the peak of what asset-management companies are going to be worth for a long time.” As a result, he adds, other big-name brokerages – most notably Merrill Lynch – could start jettisoning their own asset-management units.

Old line

Berkshire’s Nesvold thinks Legg Mason’s concentration on asset management works well within its overall plan, however. “Legg Mason has figured out that asset management is an attractive business,” she says. “They’ve been moving very deliberately and very thoughtfully in this direction for some time.” Right now more than 70% of Legg Mason’s earnings and 56% of its revenue come from asset management, according a company press release. Once the Citigroup swap is completed, all of its earnings and revenue will come from managing money.

But shedding its broker-dealer business doesn’t spell the end of Legg Mason as an advisor, says Nesvold. The company has eight “old-line” private-client affiliates, with investment minimums from $1 million to $2.5 million. Those firms are Barrett Associates, Bartlett & Co., Berkshire Asset Management, Legg Mason Focus Capital, Legg Mason Investment Advisors, Legg Mason Investment Counsel, Private Capital Management and the Seifert Group, an investment team within Barrett Associates. Legg Mason also owns Legg Mason Trust and operates, as a joint venture with the law firm Bingham McCutchen, a multi-family office called Bingham Legg Advisers. –FWR

Purchase a reprint of this story.