Pimco: A sovereign under siege
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When Doug Hodge addresses the quarterly meetings of Pimco’s 2,600-strong staff, he typically signs off with a single word, a linguistic flag for the troops to march under. Mr Hodge is the operations guy at the giant bond fund manager, and when he spoke to employees this week – for the first time since his elevation to chief executive in a forced reshuffle that shocked the investment industry – the word he left them with was this: “Grit.”
The appeal to resilience and determination is apposite in a period that ranks among the trickiest and most unpleasant in Pimco’s history.
Mohamed El-Erian’s unexpected resignation as chief executive and co-chief investment officer in January, after he tired of the gruelling travel and rows with Bill Gross, Pimco’s founder and investment supremo, set off a chain of events that has seen clients questioning the firm’s culture and re-examining their investments. It comes after a period of underperformance by Mr Gross personally; his $236bn flagship Total Return fund has fallen into the bottom fifth of core bond funds over the past year, as rising rates hammered its holdings of inflation-protected Treasuries.
Competitors are rubbing their hands in glee. But questions about Pimco’s future predate the fractious end of the “Bill and Mohamed show”, and will continue even as the personal drama recedes.
Now the company must recast a succession plan for the 69-year-old Mr Gross at the same time as expanding further beyond his roots as a core bond manager, without the benefit of a bull market that put the wind at Mr Gross’s back for most of his career.
“If the bond market is going to be as treacherous as I think it might be, Bill Gross is going to be a tremendous competitor,” says Michael Lipper, who has tracked the rise of Pimco over four decades, first through the mutual fund data company that bears his name and now as an adviser to endowments and wealthy families.
“They ran him out of Vegas because he was a blackjack card counter. He is playing to become the very best at what he does and he will find out how to dance through a flat or slightly declining bond market.”
When Mr El-Erian resigned, Pimco planned to introduce a new management structure with Mr Hodge taking the chief executive role and three deputy chief investment officers under Mr Gross. However, within hours of the announcement, Marc Seidner, an El-Erian lieutenant who was also fed up with the tensions, said he was quitting to run fixed income for GMO in Boston.
The announcement went out with two deputy CIOs, and Mr Gross appointed an additional four a week later, each with expertise in different product areas – six princes below the Bond King.
That Mr Gross’s competitive nature makes him an unforgiving boss is no secret, and stories of his temper are legion, but investors have regarded it as a side-effect of brilliance rather than a cause for concern.
The reasons for Mr El-Erian’s exit, and Mr Gross’s sometimes startling public reaction to it, have prompted a second look at what Morningstar analyst Eric Jacobson calls the “pressure cooker atmosphere” inside Pimco’s headquarters in Newport Beach, California.
The Financial Times reported the day after Mr El-Erian’s departure that tension with Mr Gross was partly to blame, and when The Wall Street Journal later described the furious arguments between the two, it prompted a reaction from Mr Gross. “I’m so sick of Mohamed trying to undermine me,” he said, according to a Reuters article, which also said Mr Gross had indicated he was monitoring his fellow executive’s phone calls. At the time, Pimco disputed the accuracy of the quotes but Reuters stood by its story.
Neither Mr Gross nor Mr El-Erian agreed to an interview for this article.
Morningstar, whose recommendations are widely followed by retail investors and their advisers, downgraded its “stewardship” rating on Pimco’s funds, for fear that the new deputy CIOs might not have the “temerity” to challenge Mr Gross and that the decisions of Pimco’s investment committee would be less robust as a result. But Mr Jacobson has not changed his overall assessment of the Total Return fund, which he reiterated in a conference call for financial advisers on Wednesday remains “a compelling choice”.
Repeated bouts of underperformance by Pimco funds, or evidence of sustained outflows, could change that view, Mr Jacobson said, but “we believe Bill Gross is no less the investor than he was prior to Mohamed El-Erian’s departure”.
That assessment appears to be shared by investors and consultants. Edward Jones, for example, the largest network of independent financial advisers in the US, is keeping the Total Return fund on its recommended list.
However, Mr El-Erian’s departure prompted many institutional clients to put their Pimco holdings on a formal “watchlist”, which means they will be subject to greater scrutiny. Certainly Pimco’s rivals hope to prise some of its $1.9tn into their own hands.
“It would be poor form to talk down a competitor,” says Matthew Appelstein, head of US distribution at RBC Global Asset Management, “but we can talk about the ‘efficient frontier’ for a portfolio and the optimal risk-return trade-offs.” Like many, RBC’s pitch to investors is that it would be prudent to shift a portion of their Pimco allocation to another firm.
BlackRock in particular is ready to pounce. The biggest money manager in the world, BlackRock’s fixed income business performed poorly during the crisis, in stark contrast to the resilience shown by Pimco. Now, BlackRock is pointing to better comparative numbers as the crisis period is falling out of the five-year performance record that many retail and institutional investors use to assess potential managers.
Another large bond manager says it has circulated newspaper articles about the infighting in Newport Beach to its sales staff.
Investment performance will settle the short-term battle for market share in fixed income. Mr Gross had what he called a “stinker” of a 2011, too, missing a rally in US Treasuries, but he bounced back in 2012. This past year’s underperformance has not been confined to the Total Return fund; the average Pimco mutual fund is in the bottom half of its class over a one-year horizon, according to Morningstar. But Pimco says the figures do not include accounts managed separately for institutional clients and therefore do not reflect the firm as a whole.
Its fixed income focus, representing 90 per cent of its assets, means it is losing market share to rivals with a wider suite of products. Rising interest rates render its core menu of investment grade bonds less attractive than they have been over the past three decades.
The larger question is whether Pimco can grow in a new investment era. Can it repeat the success it has had in core bonds in other products? Can the Bond King and his princes stand out from the crowd of stock pickers in the equity markets, too?
Pimco insiders say they have made more progress than they have been given credit for. Core bond funds, two-thirds of assets under management at the start of the 2000s, now account for less than one-third. New products include racier credit funds, high yield and hedge funds and real estate.
Pimco has also signalled a willingness to push more aggressively into equities. Virginie Maisonneuve, poached from Schroders to head the equities division, was promoted to one of the deputy CIO slots within days of arriving at the company. She plans to expand the equities staff from 50 to 65, with further hiring to come after that.
Former employees report that tensions in Newport Beach escalated last year as Pimco continued its expansion into broader business areas, which they said did not appear to keep Mr Gross’s attention. The newly reconfigured investment committee will be chaired in rotation by the new deputy CIOs as well as Mr Gross. “The deep sector experience they bring should be a big plus,” Mr Jacobson wrote, “but it’s reasonable to wonder whether these highly skilled but less-seasoned folks will have the confidence and temerity to stand up to Gross’s dominant presence and reputed temper.”
Pimco’s parent company, Allianz, has welcomed the broader management bench and it expects Mr Gross’s successor as CIO to emerge from there.
So far, the German company has hung back and respected the terms of a deal that granted complete investment autonomy and considerable operational freedoms to Newport Beach, sources on both sides say. Its involvement has been limited to an attempt to persuade Mr Gross and Mr El-Erian to go to mediation to resolve their differences, and approve the operational management changes. Analysts have speculated that, by keeping Mr El-Erian on the Allianz payroll in the new post of chief economic adviser to the parent company, he would remain available to be parachuted in.
Sources familiar with Allianz’s thinking say this is not the case, while those who know Mr El-Erian say he does not wish to return. He is concentrating more on his writing, which includes columns in the FT, and plans a book on modern central banking.
Together, Mr Gross and Mr El-Erian were the prolific faces of Pimco, appearing regularly in print and on business television. But the company is now highlighting the prodigious research output of the portfolio managers below them, which was often overshadowed by Mr Gross’s attention-grabbing tweets, blog posts and TV appearances. The quarterly “cyclical forum” this month, when portfolio managers debated the investment outlook, will yield numerous articles from managers around the world, the company promises.
From Ms Maisonneuve, through Andrew Balls in London and mortgage specialist Dan Ivascyn, to Mihir Worah, Scott Mather and Mark Kiesel, the new deputy CIOs are also being introduced in full-page newspaper advertisements as “a constellation of stars”. Behind their six photographs and biographies, however, the background picture is of a full-page size Bill Gross.
“The idea he runs a one-man show is absolutely inaccurate,” says a long-time trustee of Pimco mutual funds. “He cannot manage the full $2tn. It hasn’t been that way for years. It is a driven firm, and to meet client expectations they work hard. 2013 wasn’t up to their standards but they will get back there.”
Mr Hodge points to Morningstar’s positive assessment of the Total Return fund as evidence of the strength of Pimco. “Our new deputy CIO model is working. On the entire $1.9tn of assets that we manage, year to date we have generated over 1 per cent of annualised outperformance,” he says, citing an internal metric that measures the returns of mutual funds and institutional mandates versus their benchmarks.
“We will continue to work relentlessly every day to deliver the industry-leading value and performance that our clients have come to expect from us.”
At Newport Beach, Mr Gross is said by visitors to have become “contemplative” about his management style but as driven as ever to beat his competitors and rebut his critics. Meanwhile, the task of managers has been to screen out the negative headlines, deal calmly with investors’ questions about the new investment processes, and carry on business as usual.
In that vein, last week, scores of children poured past surf boards and buckets and spades at the office doors and assembled in the firm’s famous trading floor for a beach-themed “take your kids to work day”, an annual tradition. Not so much grit as sand.
Funds: JPMorgan takes the bragging rights
When it comes to the tussle for market share in the asset management industry, Pimco’s pain is someone else’s gain. Last week JPMorgan Asset Management sent a triumphant internal email.
According to its own preliminary estimates, it has overtaken Pimco and is now running the largest fund in the fast-growing category of “alternative” bond funds, which are a popular place for fixed income investors to put their money while interest rates rise.
Bill Gross’s decision to assume personal control of Pimco’s Unconstrained Bond fund was not enough to prevent it being surpassed, as the battle for fixed income supremacy moves on to new turf.
Alternative bond funds, sometimes called “unconstrained” or “absolute return” funds, allow the fund manager to behave more like a hedge fund manager. That means taking a wider variety of bets, including negative bets on the fixed income markets, and using more esoteric derivatives. Because traditional bonds are mathematically guaranteed to go down in value when rates rise, these more flexible funds have been heavily marketed to clients since Ben Bernanke unleashed his taper talk last summer.
JPMorgan’s Strategic Income Opportunities fund hit $25.8bn in assets last week, according to the internal email, up from $15.3bn a year ago and edging out Pimco’s fund, which suffered outflows in each of the six months to February, according to Morningstar, the research house.
The new fund’s manager, Bill Eigen, was formerly a manager at Highbridge, JPMorgan’s hedge fund business. That background, he says, gives him an edge over traditional core bond managers. The aim is to produce a positive return, regardless of what is happening to rates.
“An absolute return strategy demands expertise, and it demands that you have made mistakes. I have made tons of mistakes over the years, but one thing I know is I’ll not make them again, because now they are incorporated into the risk model,” says Mr Eigen.
Mr Gross took over the Pimco fund in December, after Chris Dialynas, its manager of five years, said he would take a sabbatical. He has since shifted money from super-safe US Treasuries into riskier corporate credit.
Assets in alternative bond funds remain small compared to core fixed income, but have jumped 62 per cent to $131bn in the past year, on Morningstar figures.