Legg Mason CEO Fetting in race to reverse outflows

* Assets under management down again in Q2

* Fetting says "on the cusp" of positive flows

* Share buyback, restructuring have helped stock in 2010

By Ross Kerber

BOSTON, July 13 (Reuters) - The last few years have been tough for famed Legg Mason Inc (LM.N) stock picker Bill Miller, but that is just one of the challenges facing Miller's boss, the asset management firm's chief executive, Mark Fetting.

Legg Mason's chief financial officer just quit. Activist investor Nelson Peltz sits on Fetting's board. And investors are still pulling money out of the company's funds.

Analysts want to see if Fetting can help Legg Mason more fully recover from the 2008 credit crisis, when the firm suffered huge losses in the structured investment funds it acquired from Citigroup in 2005.

Legg Mason shares fell more than 70 percent in 2008 and are still down more than 50 percent from levels early that year. By comparison, shares of rivals like Franklin Resources (BEN.N) and T. Rowe Price (TROW.O) have recovered most of their losses since early 2008.

Fetting, 55, at the helm of the Baltimore company since January 2008, has made some recent moves that were well received.

A $1 billion stock buyback, representing over 20 percent of the company's market capitalization, has helped Legg Mason shares outperform other asset managers so far in 2010 .GSPAMCB.

Skeptics acknowledged the buyback and cost-cutting plans announced in May -- including laying off 350 workers, or about 10 percent of the company's workforce -- but said they cannot ignore the ongoing outflows from Legg Mason's family of funds.

The test now is how quickly Fetting can restore net inflows and improve Legg Mason's operations, said Jay Kilroy, a portfolio manager at Willis Investment Counsel in Florida, which owns about 430,000 Legg Mason shares.

Otherwise, Kilroy said, the company could become a takeover target for one of its larger rivals. "Fetting is in a bit of a race against time," he said.

Fetting has argued that better investment performance will eventually speak for itself. "We are on the cusp of getting into positive flow territory, and we're tasting it in some places," he told Reuters.

Preliminary figures on Tuesday backed up Fetting's confidence. Legg Mason said assets under management (AUM) as of June 30 were $645.4 billion, down from $684.5 billion at the end of March and $656.9 billion a year earlier.

But equity AUM fell just 4.4 percent to $155.8 billion, better than the AUM-weighted average performance of Legg Mason's equity mutual funds, which were down 6.1 percent, and the 5.5 percent decline in the S&P 500 index .SPX.

"We think equity net flows were meaningfully positive," analysts Michael Kim and Michael Sarcone of Sandler O'Neill said in a research note.

A CASH MACHINE

Legg Mason is not alone in struggling through years of economic uncertainty. But its fall from grace -- the stock peaked at $139 in February 2006 -- has been notable.

Not everyone wrote off the firm, however, including Peltz, who took a board seat last fall in a deal that capped his Legg Mason holdings at 10 percent for two years.

Fetting has worked at Legg Mason since 2000 and helped shape the company, including the 2005 deal in which the firm swapped its brokerage for Citigroup Inc's (C.N) asset-management business.

In interviews, Fetting said the recent restructuring made Legg Mason more flexible by putting more workers under the control of units like its Western Asset bond division and ClearBridge Advisors for equities.

He also stressed the company's ability to generate cash. Although Legg Mason trades at about 22 times earnings, high among its peers, its multiple is lower to cash earnings, excluding costs like amortization.

"People miss the value that's embedded in our price," Fetting said.

BREATHING ROOM

Some feel Peltz now exerts considerable control over the company. But so far, Peltz and another investment firm on Legg Mason's board, Kohlberg Kravis Roberts & Co [KKR.UL], have given Fetting breathing room to get the firm on track and get flows moving in the right direction.

Fixed-income funds, the company's largest segment, reported net outflows again in the second quarter. Fixed-income AUM fell to $357.9 billion on June 30 from $364.3 billion at the end of March.

Michael Rosen, principal of Angeles Investment Advisors in Los Angeles, said the outflows may reflect months-old investor decisions. "It takes time to transition a portfolio," he said.

Then there is Miller, whose knack for finding undervalued securities made him one of the world's best stock pickers for more than a decade.

Miller famously beat the S&P 500 for 15 years running, before losing out in the 2008 bear market.

Miller's Legg Mason Value Trust fund came back in 2009 but is near the bottom of its category so far this year. In May, the company named a co-manager and Miller's eventual successor, Sam Peters. (Reporting by Ross Kerber; editing by Ros Krasny and John Wallace)