Fade to Black

Bill Gross ends an era.

[A version of this story will appear in the December issue of Chief Investment Officer Europe.]

When Larry Fink heard the news, he spent five minutes mumbling in disbelief. “Janus? Bill Gross? What?? Janus?? Are you sure?” And more colourful words to that effect.

These exclamations were captured on voicemail, according to financial legend, as a telephone near the BlackRock CEO had been incorrectly hung up after a call.

Fink’s was a reasonable reaction. He, like most people in finance, will remember where he was on September 26 when he found out “Bond King” Gross had quit the firm he founded more than 40 years earlier. The shock came not because he had quit the firm with which he had become synonymous—he had to retire sometime. The kicker was that the 70-year-old had quit PIMCO to join Janus Capital. It seemed like a very odd choice.

As Fink was coming to terms with this particular “new normal,” finance editors were demanding that staff check and cross-check to make sure someone hadn’t hacked Janus’ server and sent out false information. For their part, the phones in PIMCO’s press offices around the globe were either constantly engaged or heading straight to voicemail. It was a similar story at parent German insurer Allianz—even for Europeans, it was a long lunch break.

So, the world was left with a (verified) quote from Gross via the Janus press release, which contained some unsubtle clues about his motivation. “I look forward to returning my full focus to the fixed-income markets and investing,” Gross said, “giving up many of the complexities that go with managing a large, complicated organisation.”

But if his statement answered the one big question—he wanted to get back to managing money—it also threw up more: Why was Gross, the CIO, managing a large and complex organisation? What were the CEO and other senior managers doing? And these secondary questions go some way to revealing why that relationship, which had outlasted many in the industry, soured so spectacularly.

CIOE1214-Gross_Story_DuBois(Art by Gérard DuBois) 

“‘Everybody stop! Everybody stop trading! Don’t buy anything—or sell anything—until I say,’ Gross would say. The trading floor would just have to stop. I’ve never heard anything like it at an asset manager—bank maybe, but not a fund manager.”

An investment consultant is relaying to me the details of his recent trip to Newport Beach. He was one of multiple consultants who boarded a plane and headed to the US’ West Coast at the end of September. “I just couldn’t believe it,” he continues. “I didn’t see it myself, of course—Gross had already gone by the time I was there—but I was told this by a very reliable source. I heard massive deals that investment banks had been working on for weeks with PIMCO just had to be shelved. These trading freezes could last for minutes, hours, or days—it sounded crazy to me.”

The consultant says PIMCO staff told him actions such as this were demonstrative of the CIO’s “increasingly erratic behaviour.”

It was no secret that there had been anxiety in the PIMCO household over the previous 12 months. It is never a good sign when the press can publish leaked anecdotal evidence of angry exchanges in the office. For many, the sudden departure of CEO and Co-CIO Mohamed El-Erian in January had been the catalyst, but a switch by investors out of fixed income to better yielding products may not have helped.

The monthly outflow from PIMCO’s flagship Total Return averaged $4.3 billion in the 16 months preceding Gross’ exit, according to Thomson Reuters. While this might seem a drop in a $292 billion ocean, for the man used to being at the top of his game, this constant attrition may have contributed to stress.

And that “pressure cooker” environment was too much for some.

Marc Seidner, who had led several strategies for PIMCO, quit the firm after El-Erian took flight in January. The former Harvard endowment man had joined PIMCO in 2009 and managed several funds affiliated with Gross’ flagship Total Return Fund. He took over the company’s fledgling equities business in 2013 when Neel Kashkari, who had been instrumental to its beginning, left to run for governor of California. Seidner ceded this role to Virginie Maisonneuve in October 2013, but stayed with the firm until he agreed to set up a fixed income arm for the famously long-term equities house GMO.

Michael Spence, a professor of economics at New York University, had been a consultant to PIMCO since 2009. The Nobel Laureate quit his position at the fund manager in February.

Jeremie Banet joined PIMCO in 2011 as a real return portfolio manager. He quit in June and exchanged the heat of fixed income markets with that of the kitchen, opening a toasted sandwich-making stall.

That people leave fund managers is not a surprise. That people leave well-compensated fund managers is not a surprise. What is a surprise is that these three high-ranking staff all jumped out of PIMCO when El-Erian left, and bungeed back in once Gross had departed.

“I always liked Bill,” says a fund management employee who used to work with PIMCO. “I thought he was cool. OK, he was a bit of a hippy, but he really loved it. He lived and breathed for it. It was never about the money for him—or at least I never thought so.”

But there was definitely a split in the camp. “There was a section of people—especially in Europe—who found him a bit much. For example, they would roll their eyes when one of his more ‘out there’ outlook pieces came out,” says the finance worker. “There will be plenty of people who won’t be sad he’s gone.”

There seems to be no consensus on the character of Bill Gross. Certainly his outlook pieces are often rooted in intangible theories that struggle to square with the concreteness of financial markets, and his laid-back interview style does not suggest an uptight dictator. On the other hand, to win in financial markets—and PIMCO undoubtedly done that—you need a backbone and shoulders of steel.

“There was a section of people—especially in Europe—who found him a bit much. There will be plenty of people who won’t be sad he’s gone.”

Gross’ origins are not like many others’ in asset management. He grew up in California after moving from Ohio as a child, and earned his first degree (in psychology) there in 1966. He joined the US Navy and earned an MBA from UCLA Anderson School of Management in 1971.

From there, it was all hard work. While working at Pacific Life Insurance, he founded the Pacific Investment Management Company in 1971 with starting assets of $12 million. In 2000, German insurer Allianz took a majority stake in the company—now with $250 billion in assets under management—but Gross, as the remaining co-founder, was left relatively autonomous. In the first 30 years, PIMCO’s assets grew steadily, but it could be argued, so did the fund management market in general. In the 14 years that Allianz has owned the company, PIMCO’s assets under management have more than quadrupled in size, from an already high base.

“Most people of that tenure and status leave a firm as they are not feeling appreciated,” says Brent Beardsley, senior partner in the financial institutions practice at Boston Consulting Group (BCG). Beardsley advises financial companies around the world, and while not commenting on PIMCO directly, he says that even in the cold, harsh, profit-and-loss realism of financial markets, hurt feelings are often a significant contributing factor to major events.

Let’s return to Gross’ September 26: “I look forward to… giving up many of the complexities that go with managing a large, complicated organisation.” PIMCO, as a group, is complex. Today, an internet search throws up pages of job vacancies at its various global offices in departments as varied as human resources, digital management, and events marketing. Did Gross truly believe he was managing all of that alongside the world’s largest mutual fund?

Many, both in and outside the firm, perceived that he was. “The challenge for an asset manager is creating a brand that is different from the others, that has an investment philosophy, and holds a presence in the market place,” says Beardsley. “For many, this is done through a ‘cult of personality,’ which has its own risks.”

“Gross was like the anchorman for PIMCO,” says one investment consultant. “Clients might question whether he was actually managing the money, but really it didn’t matter. You’re not going to suffer terrible performance either way.”

But the gnawing mediocre performance had already started to dent some investors’ confidence in the company. By the end of July, Total Return sat at number 77 in a peer universe of 100 in a year-to-date performance ranking by Morningstar. Over a three-year period, it sat at number 43; over five years, number 38. Even if it wasn’t losing money, given the fees investors were paying out, it was not making as much as it should—and at least one investment consultant was worried.

“It was a Friday night in April—around 7:00 p.m.—and a consultant friend of mine was frantic,” says a consultant turned fund manager. “He’d done the maths and realised the exposure its model portfolio in its fund-of-funds had to some PIMCO bond products, which had been downgraded by its research team.” The consulting firm in question runs a large fiduciary management/outsourcing arm, and thus had client money exposed to the underperforming funds. “They were the first of the consultants to move on it—many still haven’t,” he says. “Even if it’s not a straight ‘sell,’ many in the market lost conviction—and for the price their clients are paying, it’s not worth it.”

Actively managed fixed income is not the most expensive game in town, but there are still fees to be paid. Industry estimates put the average annual management fee for this sector at between 30 and 50 basis points. PIMCO’s were nearer to 70 basis points, up to even 90 on some products.

Whatever the figure is—and it is likely to be client-dependent—PIMCO has become one of the most profitable asset managers on the planet, according to Morningstar. The research firm’s Michael Herbst, director of manager research in active strategies, said in November the company had created such a lean operation its “cost structure is more attractive than most asset managers; it is more profitable.”

The company is so profitable that analysis by rating agency Moody’s in October predicted that the heart-stopping hit of Gross exiting the firm would barely touch the German insurer’s bottom line. Outflows of $91 billion in 2014 would constitute a 5% drop across the year, Moody’s figures said. It would pull down total Allianz assets to $1.72 trillion by the end of 2014 and reduce net income to the parent company by 6.35% to €5.9 billion. This equates to hundreds of millions in lost revenue, but—and it’s a $200 billon “but”—its costs have been reduced, too.

“The figure people say is $200 million a year. That’s crazy,” says an investment consultant, commenting in October on Gross’ estimated annual paycheck.

“I’ve heard $200 million a year,” says another. “And that’s for hugging—or actually being—the benchmark.”

Figures published by Bloomberg in November apparently confirmed Gross’ earnings to be actually almost 50% higher, coming in at $290 million in 2013. The newswire said this accounted for around 20% of the firm’s entire bonus pool. PIMCO said this was not accurate, but would not be drawn on the actual number. Whatever the real figure, with Gross’ paypacket gone, pressure on outflows has reduced, too, according to Morningstar’s Herbst. PIMCO could withstand outflows of $350 billion over the next two years before Allianz would be concerned, he said, and the bonus pool would be similarly unaffected.

It’s clear that Gross posed huge key-man risk to the company he founded in 1971, but is this instance different from what the market had seen before? It’s unlikely we will ever know the financial or legal terms of Gross’ departure, but the effect of his exit on the fund’s assets is already clear: It’s over.

Or rather, it’s starting to be over, according to Morningstar. Despite headlines squealing about PIMCO losing multi-million-dollar bond mandates around the world, outflows have slowed. Investors were already moving—and continue to move—out of fixed income, as the asset class is returning less and less. “After a spike in October, PIMCO now has a sustainable level of outflows,” says Herbst. “If performance was poor next year, that would increase, but it’s encouraging that those who were going to get out got out in the first two weeks, so it’s more manageable from here.”

This stands at odds with star manager departures of the past.

Amid the chaos of the financial crisis, UK fund manager Gartmore was forced to realise that putting all its eggs in a couple of fund manager baskets was folly. One manager, Guillaume Rambourg, was put under investigation—and later cleared—by the then Financial Services Authority. The other, Roger Guy, quit the firm to (truly) spend more time with his family. The firm collapsed and its shell was bought by rival Henderson Global Investors, which had also absorbed fund manager New Star after it suffered a similar fate.

More recently, Neil Woodford’s departure from Invesco saw billions of pounds in assets follow him to his own boutique, while neighbouring Barings has haemorrhaged client money since its “star” multi-asset team moved to Pictet this past summer.

“If I had known that there would be this media circus, I would have done a lot of things differently.” —Mohamed El-Erian

A notebook given out by PIMCO at a conference in 2012 shows a photo of Mohamed El-Erian speaking from a raised lectern to a group of colleagues and/or investors. In the front row, to the right of the shot, Gross is seated diagonally to the camera and gesticulating as if to be debating a point with his then co-CIO.

“We started thinking about today three years ago,” says the inscription. Whether this was just marketing, or the company truly believed it, two key players in the picture were out of the loop.

“If I had known that there would be this media circus, I would have done a lot of things differently,” El-Erian told Reuters about his departure, just three days before Gross revealed his own. “Was there a way of not going 100 miles an hour and maybe going 50 miles an hour? To be perfectly honest, I didn’t explore that option.” El-Erian, as CEO and co-CIO, was widely expected to take over from Gross. If there had been any “thinking about today,” surely these less-than-tiny details would have come up.

“It seems obvious, but asset managers must create a succession plan,” says Beardsley at BCG. “Then, they have to actually execute it, and this needs a lot of effort from all around the business. A CIO is as important—if not more so—than a CEO at an asset manager. Investors want to know what the plan is.”

However, if the two main characters of this drama were unaware of what was happening behind the scenes, some in the audience were not. In a review of PIMCO’s stewardship following El-Erian’s departure, Morningstar Senior Analyst Eric Jacobson said the investment process on Total Return gave him so much confidence that he thought it could withstand the departure of Gross himself. At the time, of course, no one even considered it would happen so soon.

“It all went very quiet,” says an institutional business head at a rival fund manager. “PIMCO pulled out of pitches in October and ducked attending large investor conferences. In fact, some of our joint clients said they’d stopped trying to call them as they were sick of not getting answers.” There has been a certain amount of schadenfreude from competitors, which is to be expected. Now PIMCO has to convince the market and investors it is back in the game.

“On that Friday,” says a business development head at a European asset manager, “everyone was going mad. Asset managers were pulling in all their staff for meetings and seeing how they could go after the PIMCO clients that would inevitably be taking their money elsewhere.” Many began shining up their absolute return bond fund brochures and making calls, he says. “It’s not that easy. People are moving out of fixed income, anyway. If clients picked PIMCO despite its relatively mediocre performance, they’re not going to dive back in with someone else.”

Thomson Reuters’ data supports this. In the week directly following Gross’ announcement, some $18.9 billion flooded into money market funds. This sector took the bulk of new money that week. “It appears a sizeable portion of the PIMCO outflows were parked in money market funds for the time being,” Thomson Reuters said.

“I would hate to be the company that just hired Bill Gross. You’re relatively unknown—at least in Europe—and then ‘bam’! Into the spotlight.”

So then it all flowed to Janus? No.

In October, Janus Capital announced net inflows of $1.1 billion—its highest gain this year. Perhaps this was unsurprising, but it’s a far cry from the $50 billion that walked from PIMCO Total Return. This $1.1 billion is likely to be “less sticky” retail money, and, of course, more will follow. However, estimates in September predicted Gross’ new fund assets would reach more than $30 billion by the end of 2016—when the manager will be approaching his 73rd birthday.

“I would hate to be the company that just hired Bill Gross,” said one fund management employee. “You’re relatively unknown—at least in Europe—and then ‘bam’! Into the spotlight.”

“They’re not rated,” says a former consultant, “and just because Bill Gross has joined doesn’t mean they will be automatically put on consultant buy lists. In any case, why would a consultant spend time rating a fund that is Google-able?”

It is not an easy transition to rise from minnow to shark in fund management—especially when you’re building a sector from scratch. Janus, which is well-respected in some equity sectors, will not be able to buy its way into fixed income investors’ pockets. “A high-profile move has the potential to be very disruptive,” says Beardsley. “And in terms of clients, the subject will take precedence over questions about investment in a lot of conversations.”

How it will work out, and how long Gross will stay put is anyone’s guess—but what has he left as a legacy at the firm he founded 43 years ago? “It’s now up to PIMCO to show they can do it—and stand behind all this ‘We Are PIMCO’ branding we’re suddenly seeing everywhere,” says a consultant. “I’d rather have five really good managers split the $200 million a year,” says another.

Morningstar’s Herbst thinks the company will be more stable going forward. “I’ve had three dozen or so conversations with key players at PIMCO over the past six weeks, and it seems the new group CIO Dan Ivascyn is fostering a more collaborative working environment.”

The bench of CIOs—or “talent,” as it is known in the trade—is impressive, and the company has already appointed 24 managing directors this year. Whether or not this flat hierarchal structure and succession plan was being built underneath Bill Gross—and to an extent El-Erian—is no longer relevant. That chapter is closed. Both PIMCO and Janus now have something to prove: the former, that it can endure; the latter, that it can build. And for the man who spent more than half his life building up the largest and most successful fixed-income manager in the world?

An off-the-cuff comment from Herbst sounds strikingly true: “Bill Gross’ departure is a short-term negative for PIMCO.”

It must cut the so-called Bond King like a knife.