Franklin: Leech’s Departure and Ongoing Investigations Will Weigh on Fixed-Income Flows

Key Morningstar Metrics for Franklin Resources

• Fair Value Estimate: $24.00
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: High

We’ve lowered our fair value estimate for Franklin Resources BEN to $24 per share from $26 to account for revised near-term expectations for managed assets, revenue, and profitability since our last update. The shares are moderately undervalued, trading down more than 10% on Aug. 21 after news that the firm put Ken Leech, co-CIO for Western Asset Management (Franklin’s bond subsidiary), on a leave of absence, tied to a Wells notice he received from the SEC. Michael Buchanan has been elevated from co-CIO to CIO.

Franklin closed its fiscal third quarter with $1.647 trillion in total assets under management and long-term AUM (which excludes money-market funds and non-management fee-earning AUM) of $1.582 trillion. The firm recently reported total AUM of $1.663 trillion for July 2024, and we expect it to close out the year with a similar figure.

Net long-term outflows of $3.2 billion during the June quarter were much better than the quarterly run rate of $7.5 billion in outflows during the previous eight quarters. While this left Franklin on pace to generate from negative 1% to no organic AUM growth in fiscal 2024, we expect flows at Western Asset Management to continue to be pressured. We now envision the firm producing average annual organic AUM growth in a negative 3% to negative 1% range during fiscal 2024-28. With total and average AUM likely to expand at an average low-to-mid-single-digit rate annually over our projection period, Franklin is expected to generate a positive 1.7% CAGR for revenue growth, with adjusted operating margins in the 25%-30% range during fiscal 2024-28.

At this point, we know little about the shakeup at Western Asset Management. Leech’s departure comes just a few months after another key leader, John Bellows, abruptly left the firm. Like Leech, Bellows was thought to be a key part of the firm’s long-term plans. His unexpected exit in May was a blow, especially now that Leech is no longer in the picture, and there has been some fallout from his departure.

Franklin noted in its recently filed 10-Q that it launched an internal investigation into certain past trade allocations involving treasury derivatives in select Western Asset-managed accounts and is currently cooperating with parallel government investigations that led to the issuance of the Wells Notice to Leech. The firm said it does not expect to take action until the investigation is concluded. That said, following Leech’s leave of absence, Franklin decided to close his Macro Opportunities Strategy fund, which had around $2 billion in AUM at the end of last month. All this could lead to a loss of confidence for a fixed-income firm that caters primarily to institutional clients, who are known to cease relationships following the departure of key personnel and/or reports of government investigations.

This also speaks to our long-running critique of Franklin’s hands-off approach to its different investment franchises. With each of its fund families responsible for the hiring, training, and oversight of its personnel and investment disciplines, Franklin has at times allowed these subsidiaries to make larger and riskier bets (as well as other types of activities), which can have an outsize impact.