The Divided Kingdom of Newport Beach

Bill Gross and PIMCO: Is there room in this town for the two of them?

CIO-April-2015-Scene-and-Heard-1-Marcellus-Hall-storyArt by Marcellus Hall“Immerse your business in this vibrant and energized community where you will be amongst the most prestigious global companies in the world,” the developers of luxury office high-rise 520 Newport Center advertise.

In other words, “Move in here and you’ll be close to PIMCO.” 

The first tenant in the 21-story tower: Janus Capital. The Denver, Colorado-based asset management shop signed a lease for 2,500 move-in ready square feet last October—a sort of post-divorce, furnished bachelor pad for its newest portfolio manager Bill Gross.

“I think everyone was taken aback, surprised, and a little sad to see this happen,” says Amy Hsiang, head of fixed-income research at consulting firm RVK. From 2006 to 2010, she worked at PIMCO, developing products for its low-duration strategy and working with institutional clients. When the news broke that the Bond King had left his castle, Hsiang found out the same way as the rest of the industry—and most of Gross’ underlings. “I literally saw it in the press: it leaked before everybody at PIMCO knew about it,” she recalls. “I was on the phone constantly with my direct contact or my friends. They didn’t know who was going to take over or what was going to happen.”

As of February, one-third of the riches in PIMCO’s open-ended US mutual fund and ETF coffers had, since the height of Gross’ reign in 2013, departed along with its founder. Where the court and CIOs-in-waiting found uncertainty and relief at Gross’ abdication, competing powers smelled blood in the water, and started hunting.  

“We appreciate the lowered fees, but I’m not going to recommend a manager based on something so reactive.” —Amy HsiangIn what was surely no coincidence, following Gross’ exit the price tag on longtime competitor BlackRock’s Total Return product dropped from 52 basis points to 45—undercutting PIMCO flagship Total Return fund by a single point. Last October, OppenheimerFunds and Lord Abbett followed suit: A-shares of their intermediate-term bond strategies dropped six and 17 basis points, respectively.

“Competitors were pretty aggressive in trying to get those assets,” Hsiang says. “Some players came out with a mutual fund; others lowered their fees to match Total Return. That to me is market noise: We appreciate the lowered fees, but I’m not going to recommend a manager based on something so reactive. I’m always a little put off when you see managers gleeful over another’s demise.”

Apparently, she’s not alone in that.

Two of the firms most successful in picking up—or picking off—ex-PIMCO capital have tactfully avoided the circling-vulture approach of their more aggressive peers. San Francisco-based Dodge & Cox and TWC, headquartered in Los Angeles, played a subtler game. Dodge & Cox keeps under the radar and its overhead low by eschewing advertising, marketing, and public relations. Yet its CEO and CIO granted a rare interview to Barron’s in January, which published a feature so fawning that no ad campaign could have hoped to compete.

TCW likewise resisted a marketing blitz or fee-cutting stunt. Both California firms have for years competed favorably on price with the giant to the south, and their fees haven’t changed post-Gross. Assets under management, however, certainly have. As of February, TCW’s Metropolitan West Total Return fund—creative naming not being bond houses’ strong suit—had grown 127% in a single year. All of that $120 billion pulled during the year from PIMCO’s Total Return had to go somewhere.

Where it hasn’t gone: Five minutes down the road to Gross’ suite in 520 Newport Center. The global unconstrained bond strategy Janus launched in May 2014 lost $18.5 million in February, according to Morningstar, bringing the fund to $1.5 billion under management. Roughly a third of that belongs to George Soros’ Quantum Partners, a private vehicle that allocated $500 million last fall.

“We didn’t really imagine that any of Bill’s former colleagues at PIMCO would follow him—I don’t think anybody did.” —Former PIMCO employeeFor the close proximity Gross maintains to PIMCO—both geographically and professionally—it’s remarkable how isolated the two entities have become. Neither staff nor assets followed the firm’s founder to his new seat; most remained loyal to the institution rather than the man.

“Before Bill’s departure, it was a very difficult time,” says a former member of the investment staff. “Everyone knew he was going to be leaving, but they weren’t sure how or what would happen. And he did it like pulling a Band-Aid off—and it wasn’t a gentle pulling.” Asked why the Bond King didn’t depart with an entourage of deputies, the ex-employee paused, as if the answer was strikingly obvious. “Bill was setting up a brand new thing: He didn’t have a team or even an office. We didn’t really imagine that any of his former colleagues at PIMCO would follow him—I don’t think anybody did. It would be a big professional risk.”

That the opportunity to enter on the ground floor of a new venture alongside one of the greatest investors of all time is “a big professional risk” demonstrates either (a) the profoundly conservative nature of bond investors, or (b) how deeply fractured Gross’ relationship with the rest of PIMCO had become. Or, most likely, a mix of both.

But while employees largely stayed put, assets didn’t—and emotion may also be the driving force behind PIMCO’s fleeing investors. The March Morningstar update on US asset flows titled its fixed-income section “It Never Ends: PIMCO Down a Third of December 2013 Assets.” Author Alina Lamy, a senior analyst for markets research, detailed capital losses in the hundreds of billions for the once-unshakable institution—despite improved returns since its founder’s exit.

“At this point, the longer-term monthly outflows seem to have almost nothing to do with performance and almost everything to do with a phenomenon I would call—to borrow a term from physics—investor inertia,” Lamy wrote. “It’s as if the momentum of past redemptions keeps propelling investors forward in the same direction, irrespective of other forces such as performance, quality of management, or overall reputation of the firm. As the next few months unfold, it will be interesting to see just how far investors can let inertia carry them.”

If Bill Gross gets his way, they’ll go about five minutes down the road.