Fund Objective

The objective of this Fund is to achieve capital growth, principally through investment in securities of US issuers.

View on Past Performance

The Legg Mason US Equity Fund outperformed the S&P 500 by 48 basis points in June, gaining 4.39%2 in sterling terms versus a 3.91% gain in sterling terms for the Index. Year-to-date, the portfolio trails the S&P 500 by 196 basis points, up 2.40% in sterling terms versus a 4.36% gain in sterling terms for the Index.The month of June saw declines in some of our investments that had performed well in the previous five months. For example, Sprint Nextel (down 9% in the past month) and Qwest Communications International (down 6%), two telecom holdings that had appreciated more than 20% through the end of May partly on LBO (Leveraged Buy-out) speculation, gave back some of their gains as deal prospects abated and company-specific concerns loomed.Specifically, those investors who were drawn to Sprint Nextel hoping for a quick turnaround got cold feet at the thought of a potential shortfall in second-quarter net subscriber additions amid stiff competition. At Qwest, the unexpected resignation of CEO Richard Notebaert dashed the hopes for a quick sale of the company.While short-term-oriented investors may deem these developments disappointing, we have found nothing in them to change our view that business fundamentals should continue to improve for the two companies.

Future Expectations

We spent longer on the political discussion than we originally intended, but the Outlook section should be shorter than usual because we really don't have that much new to say. We continue to believe that low-teens returns for the S&P 500 Index for the year are a reasonable expectation, assuming 10-year US Treasury yields stay at 5% or lower. If long rates rise from here, double-digit returns for the S&P 500 this year will be more of a challenge.As far as Fed policy is concerned, not much has changed there in the last 30 days either. As expected, the FOMC maintained the Fed funds rate at 5.25% in a unanimous vote that marked the one-year anniversary of the committee's decision to raise rates to that level in June 2006.Fed Chairman Ben Bernanke and other Fed governors continue to talk tough on inflation - as they must to maintain their inflation-fighting credentials - but, given the recent moderation in core inflation, we believe it is quite unlikely that they will feel the need to raise rates. Fed fund futures market participants now expect the Fed to be on hold well into 2008, which seems like a reasonable bet to us.With the 10-year Treasury at 5%, based on what we regard as reasonable assumptions for long-term growth (6% to 7%) and returns on equity (16% to 17%), we believe the market is worth between 15.5 and 16.5 times earnings. The S&P 500 trades near the mid-point of that range based on 2007 cap-weighted consensus estimates and one or two multiple points cheaper (depending on which end of the valuation range you use) based on consensus expectations for 2008.Others are more optimistic about the market over the next 12 to 18 months. For example, FTN Midwest Research strategist Tony Dwyer, whose work we admire, thinks the S&P 500 will trade at 18 times his 2008 earnings estimate of $100 before the end of 2008, suggesting nearly 20% upside in the market over that time frame. He notes that the S&P 500 Index traded at a multiple of 18 or higher in the last two bull markets, in an environment of long rates higher than those that prevail currently.

Fund Details