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Legg's Achilles' Heel

The earnings report of asset manager Legg Mason (NYSE: LM  ) on Tuesday revealed an aching equity muscle troubling a capable body.

As a strong stock market helped peers such as Ameriprise (NYSE: AMP  ) , Franklin Resources (NYSE: BEN  ) , Janus Capital (NYSE: JNS  ) , and T. Rowe Price (NYSE: TROW  ) post solid figures last week, Legg did likewise. The second-largest publicly traded money manager posted a 22% increase in its first-quarter profit to $191 million, or $1.32 per share, compared to $156 million, or $1.08, a year earlier. Contributing to the bottom line was a 16% rise in revenue to a record $1.21 billion, boosted by a 16% increase in assets under management in all asset classes to $992 billion, and strong performance from its hedge fund business. Permal Group, manager of Legg's funds of hedge funds, has doubled in size to $35 billion since the firm bought it 20 months ago, and generated significantly higher performance fees.

All this sounds great, but there's one important sore spot. The growth in assets under management, a key component to a money manager's bottom line, is largely attributable to market appreciation. Legg managed to attract a net $2 billion in new money, but that's after accounting for the $7 billion withdrawn by clients from its equity funds. Some of Legg's better known equity funds such as Legg Mason Value Trust (LMVRX) and Legg Mason Partners Aggressive Growth (SHRAX) have suffered disappointing performances in recent years. Management admits that performance improvement is needed, much as it had the previous quarter when CEO Raymond "Chip" Mason noted the underperformance, which he believed would be "self-correcting" as the market became more favorable to the U.S. growth bias of the funds.

The firm's first-quarter results point to Legg running along, benefiting from its product breadth, diverse client base, and broad distribution channels. According to founder and CEO Mason, the firm's first priority going forward is the purchase of an international asset manager, and the second is the repurchase of its stock. Meanwhile, the firm can't fully hit its stride as long as equity underperformance remains Legg's Achilles' heel.

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Fool contributor S.J. Caplan does not own shares of the companies discussed in this article. The Fool has a disclosure policy.

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