Why We Downgraded These Western Asset Bond Funds

Morningstar’s fixed-income manager research team has lowered the People ratings on Western Asset Core Bond WATFX and Western Asset Core Plus Bond WACPX to Average from Above Average.

Morningstar analysts downgraded the funds in the wake of Western’s decision in August to give co-CIO Ken Leech a leave of absence amid legal and regulatory investigations. Our analysts conducted in-depth due diligence that included conversations with legal professionals from Western and Franklin, as well as Western’s key investment decision-makers, before making the decision.

Western Asset said on Aug. 21, 2024, that Leech was taking a leave of absence amid ongoing US Securities and Exchange Commission and Department of Justice investigations into US Treasury derivative allocations made by Leech in a number of Western accounts. Parent firm Franklin Templeton, which acquired Western in 2020, first reported its joint internal investigation with Western in a July 26, 2024, regulatory filing, but Leech’s involvement wasn’t clear until Western’s announcement the following month.

While the investigations into Leech’s trading activities are still ongoing, based on the information made available so far, Morningstar does not believe the firm’s risk and trading processes failed. So, we did not touch the Process Pillar ratings of the firm’s funds. Morningstar maintained Above Average Process ratings for Western’s flagship funds because we think the firm can still deliver strong returns over a market cycle and is striving to improve its strategies’ risk/reward profiles. Western’s broad markets team, for instance, has taken steps to rein in portfolio volatility that has swelled from already-high levels in 2022 when correlations between credit and interest-rate risk broke down.

Still, long-term concerns linger, especially given that Leech’s exit wasn’t Western’s only big personnel loss this year. John Bellows, a trained economist and influential manager who had taken over as lead manager of the core and core-plus strategies in 2023, exited the firm abruptly on May 1, 2024. These two losses give us pause about the affected strategies’ futures, even though the firm still has a lot of experienced personnel.

Core Bond’s share-class Morningstar Medalist Ratings now range from Neutral to Negative, depending on fees, while Core Plus’ cheapest share classes retained their Bronze ratings. The funds get different Medalist Ratings despite having the same People and Process ratings because they are in different categories with different competitive dynamics and return expectations.

Morningstar Medalist Ratings Changes

July 2024 Morningstar Medalist Ratings are from before the strategies were placed under review.

Western Asset Macro Opportunities LAOIX, the lone strategy Western opted to close in the wake of Leech’s departure, was the only other fund to receive a downgrade. Morningstar lowered the People and Process Pillars of the strategy that will liquidate in October 2024 to Average from Above Average.

Leech’s top-down US broad-market macro calls did not influence any of the firm’s other strategies as much, so his departure did not warrant downgrades to their ratings.

Morningstar Manager Research Ratings

Fund identifiers include tickers or ISINs depending on the vehicle's primary domicile.

What Happened?

Western Asset announced on Aug. 21, 2024, that co-CIO Leech began a leave of absence, and that Michael Buchanan was taking over as sole CIO amid ongoing investigations from the US Securities and Exchange Commission and the Department of Justice. These investigations concerning the allocations of US Treasury derivatives across an undisclosed number of Western accounts managed by Leech are still ongoing, as is the independent investigation Western and its parent firm, Franklin Templeton, started in October 2023. The SEC became involved a month later.

Franklin first disclosed the matter in its second-quarter regulatory filings on July 26, 2024, but Leech’s name wasn’t mentioned until Western’s August announcement. At that time, Western announced Leech’s leave of absence and that he had received a Wells notice from the SEC. Wells notices are the SEC’s way of notifying people and firms that it plans to bring an enforcement action against them. Leech’s notice regarded his allocations of Treasury derivatives and gave him 30 days to respond. The SEC has yet to release its findings, nor any potential actions it may levy against Leech.

Leech had built an excellent reputation and long, successful career. He joined Western in 1990 and was instrumental in its rise as a fixed-income firm over 34 years, helping to grow assets to over $300 billion in 2023 from just over $5 billion when he arrived. Leech amassed numerous industry accolades during his lengthy tenure as CIO and portfolio manager, including Morningstar’s US Fixed-Income Manager of the Year award in 2014, which he shared with the rest of his team.

Leech was expected to retire in coming years, so Buchanan’s appointment as sole CIO is not a surprise. Unlike Leech, his experience is rooted in credit; he previously led Western’s US high-yield team after joining the firm in 2005 before rising to deputy CIO in 2015. Western named Buchanan co-CIO alongside Leech in early September 2023 as part of their succession-planning efforts. Aside from CIO duties, Buchanan leads the firm’s global credit committee and retains multisector portfolio management responsibilities.

Investors Heading for the Exits

Some investors didn’t wait for the investigations to conclude before pulling their money.

Within Western’s seven analyst-covered US-domiciled strategies, the news most affected Core Bond and Core Plus Bond. Those funds saw a respective 36% and 31% of their assets redeemed through Sept. 17, 2024, relative to their assets under management on Aug. 20, 2024, the day before Western’s announcement.

Western Asset US Fund Flows

Net flows between Aug. 21, 2024, and Sept. 17, 2024, were calculated as a percentage of Aug. 20, 2024, fund assets under management.

According to Morningstar Direct data, Western Asset Core Bond’s assets dropped to $8.3 billion from $12.6 billion in less than a month. Western Asset Core Plus Bond’s fell to $13.2 billion from $19 billion (these figures capture only US open-end fund assets).

While the volume of outflows has accelerated since the news of Leech’s leave, investors have been pulling money from Western’s core and core-plus strategies for nearly three years as they have posted poor performance. Core Plus has been in net outflows every month since the beginning of January 2022, while Core has seen just four months of net inflows during that period.