Asset management: Conga contemplation
By Dan McCrum
Published: May 2 2011 21:47
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| Listening mode: Bill Gross is finding ways to keep Pimco on its toes but will have to reconcile the bond investor’s house view with a move into the rivalry and unruliness of equities |
As he surveyed Pimco’s empty trading floor one weekend last summer, Bill Gross was struck by the thought that the office atmosphere was too quiet. By the following Monday morning, the 66-year-old co-founder of Pimco, one of the world’s largest asset managers, was leading a conga line around the trading desks of its normally hushed headquarters in Newport Beach, California.
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Every day since, at 8am, one song picked by an employee is played. Devil’s Haircut by Beck was a recent selection. Then the room returns to the near-silent murmur that Mr Gross prefers.
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For a company minding more than $1,200bn of other people’s money, Pimco is unusual in other ways, too. It is at the end of the financial world by timezone, operating from sleepy Orange County, far from the blue-blooded fund managers of the east coast. Yet little moves in the bond world without Pimco’s involvement.
For a company minding more than $1,200bn of other people’s money, Pimco is unusual in other ways, too. It is at the end of the financial world by timezone, operating from sleepy Orange County, far from the blue-blooded fund managers of the east coast. Yet little moves in the bond world without Pimco’s involvement.
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Much like Goldman Sachs – another “best-of-class” financial company – Pimco is both revered and feared by its peers, many of whom are wary of commenting in public. Its undoubted success in the bond markets has given it the reputation of an ability to move and shape markets.
Much like Goldman Sachs – another “best-of-class” financial company – Pimco is both revered and feared by its peers, many of whom are wary of commenting in public. Its undoubted success in the bond markets has given it the reputation of an ability to move and shape markets.
So as policymakers worldwide contemplate ending the long period of very low interest rates, and ponder bond market tolerance for ever more government borrowing, the implications of Pimco’s every action for savers, borrowers and even economies loom large. Rivals too are closely watching the firm’s reaction to the end of the 30-year bull market for bonds. Pimco has long been in the right place at the right time.
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“There has been a generation-long cycle in government bonds,” says Jeffrey Gundlach, chief investment officer for DoubleLine Capital, an asset manager. “In 20 years’ time, December 2008 will be seen as the orthodox low point for bond yields.” Bond prices go up as interest rates go down, so since 2000, an investment in a generic bond portfolio would have returned more than 80 per cent, while the S&P 500 index lost a tenth of its value.
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Pimco thus finds itself at a crossroads. Much like a carmaker whose domestic market is saturated, it must look for new opportunities elsewhere. In the money management world this means gatecrashing other asset classes. Under the stewardship of Mohamed El-Erian, chief executive since returning from an 18-month stint at the Harvard endowment in 2007, Pimco is starting with equities.
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Yet if bond managers are sober savers patiently collecting interest, equity investors are at the racetrack gossiping about form and punting on long shots. The central question is whether Pimco can repeat its trick in equities – and whether it can even attempt to do so without destroying its carefully constructed investing culture.
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At Pimco – which began life in 1971 with three people and $12m – portfolio managers are rewarded for their contribution to the firm’s overall performance, rather than their pay being linked to revenues of a specific fund as is common elsewhere. Anyone judged as being not up to scratch has money and responsibility removed, an approach that encourages what one managing director calls “constructive paranoia”. Two-thirds of managing directors have held the job for less than five years. Portfolio managers vote to commend individual contributions and elect some members of management, and everyone has a chance to shine in the hunt for ideas.
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Next week Pimco holds its three-day “secular forum”, an annual get-together to consider the big picture. Four outside “thought leaders” are invited to speak, then on the final day the stage is handed to freshly hired MBAs. “They haven’t yet drunk the Pimco Kool-Aid; they don’t know what the politically correct thing to say is,” says Mr El-Erian.
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But there are limits to Pimco’s democracy. Twin desks for the chief investment officers dominate the trading floor from its centre, where their preference for e-mail over conversation sets the tone. The battle of ideas is also very clearly refereed. “Bill and I bring it together”, says Mr El-Erian, “and it’s a bit like defining a motorway.
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It tells you whether the motorway is going: north, south, east or west. It doesn’t tell you which lane you should be driving in; it doesn’t tell you how fast you should be driving.”
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Even a casual observer of Pimco’s inner workings would recognise, however, that the two set the rules of the road. Mr El-Erian and Mr Gross alternately chair Pimco’s central decision-making entity, the nine-person investment committee, or “IC”, which meets almost every day for two to three hours – a startling amount of senior management time given to digesting the day’s new information.
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In a long conference room next to the trading floor, shades drawn to block out the California sun, television screens show a muted CNBC and a lonely European representative beamed in from London. Conversation can be combative, with the IC regularly challenged by members of three regional committees judged for their ability to influence and inform its thinking.
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However, each debate has ultimately to return to Pimco’s framework for understanding the world, laid out in green ink on a whiteboard at the end of the conference room. “All you’ve got to do is turn around and point, and people are pulled back to the objective,” says Mr Gross.
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Once the IC reaches a consensus, there is limited room for individual managers to stray far from the house view – and therein lies one of Pimco’s greatest challenges in equities.
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For instance, that framework described in green ink is a orseries of concentric circles with money borrowed direct from the Federal Reserve at the centre, representing maximum safety. It helped the company understand how investors flocked to safety in the crisis, with each ring outwards a step away from liquidity and towards risk. But only at the outermost edge of Pimco’s universe are stocks to be found, lumped in with homes, private equity, asset-backed securities, oil and high-yield debt.
Neel Kashkari, the man hired to build the new business, has a clear idea of the problem: “You can build a very efficient machine, but it won’t be very flexible, or you can build a very flexible machine that won’t be very efficient. Pimco is the former.”
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Clearly, the group can provide insight into the direction of currencies, interest rates and economic growth, which impact on more than just the bond market. “It’s like Coca-Cola: not new Coke, but we can have Diet Coke,” says Mr Gross, who argues that it can help make sense of the world for the institutions such as pension funds, endowments and insurers that entrust money to Pimco.
The economic big picture dominates the company’s thinking, however. To investors who argue that they take bets on individual assets rather than the direction of the economy, Mr El-Erian says bluntly: “You are putting on directional trades; you just don’t know about it.”
However, equity investing requires more than a top-down view. “Pimco will need to build out stock-specific and sector research teams,” says Craig Siegenthaler, asset management analyst for Credit Suisse. “When actively managing equities for third parties, it’s difficult to rely heavily on assessing broad economic trends. Instead, portfolio managers will rely more on stock selection within industries.”
Furthermore, Pimco has advantages in terms of size and access that will be less available to it in stock markets, at least to begin with. But how aggressive its approach becomes will be instructive.
When trading, the firm appears unafraid to throw its weight around. It has settled a class action suit bought against it by derivatives traders for alleged manipulation of the futures market in Treasury paper in 2005 that prompted regulatory changes to the way that market operates. And, like other very large asset managers, it receives begrudging professional respect from others as a skilled and hard-nosed participant in the trading games played between consenting adults.
“They are not afraid to spray the street,” says a bond trader for one large bank, describing the practice of issuing simultaneous buy or sell orders to several dealers at once, thereby moving the market.
Pimco is also well connected to policymakers. “We try and get as much information as possible,” says Mr Gross. “We participate in the Borrowing Committee [a group of investors that meets every three months to advise the US Treasury]. We have people like Richard Clarida [global strategic adviser] and Andrew Balls [head of European portfolio management], who like to have lunch with central bankers – I don’t think it’s inside information if it’s said at lunch and it’s all above board,” he adds. Mr Balls, a former Financial Times journalist, is frequently the London face beamed into the IC conference room.
In equities, however, Pimco will face established rivals with their own networks of contacts and trading heft. BlackRock, the world’s largest asset manager and one of Pimco’s main rivals, managed to move away from its bond investing roots, but only by splashing out on large acquisitions: first Merrill Lynch’s asset management arm in 2006, then Barclays Global Investors in 2009.
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Pimco is committing resources to the effort. Mr Kashkari is the first outsider hired at managing director level. The former Goldman Sachs banker was picked for his experience at the Treasury in establishing the Troubled Asset Relief Program, which propped up the US economy after the 2008 collapse of Lehman Brothers.
Of Pimco’s 1,800 employees, 75 so far work directly in the equity business, enough to look after more than 10 times the less than $4bn equity assets under management currently.
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“It’s very, very difficult [to diversify] but Pimco has a significant advantage in a strong brand name,” says Credit Suisse’s Mr Siegenthaler. If Pimco can demonstrate good performance, it should be able to attract money to the new business from existing investors.
The move may also reflect a subtle change within money management. Denis Bastin, a consultant to asset managers, compares today’s uncertain environment to the 1970s, where picking the right asset class was far more important than the individual stocks or bonds chosen. “We’re coming back to the good old-fashioned, broad mandate that UK pension funds used to enjoy.” The big opportunity, Mr Bastin argues, is to move from selling the big institutions narrow investment products to taking over responsibilities about where to invest as well.
For now, the company can start small, with its equity staff picking ideas from what Mr Kashkari calls “the Pimco buffet table”. But the unanswered question remains how to nurture and encourage an equity culture while the business is dominated by career bond investors.
As Mr Gross puts it: “Bond people are half-empty people and equity people are half-full people. It’s like the pessimist versus the optimist; the cold front and the warm front rotating. You get thunderstorms.”
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CLASS ACTION
In the summer of 2005 Pimco was accused of applying maximum pressure to a point of weakness in the market for US Treasury futures. A class action suit bought by a group of traders alleged that Pimco manipulated the market, squeezing small traders by taking large positions in related securities at crucial times. In response, the Chicago Board of Trade introduced new position limits in Treasury futures. Last year Pimco agreed to settle the case for $92m. The company has always argued that it was simply acting to achieve best execution for clients.
In the summer of 2005 Pimco was accused of applying maximum pressure to a point of weakness in the market for US Treasury futures. A class action suit bought by a group of traders alleged that Pimco manipulated the market, squeezing small traders by taking large positions in related securities at crucial times. In response, the Chicago Board of Trade introduced new position limits in Treasury futures. Last year Pimco agreed to settle the case for $92m. The company has always argued that it was simply acting to achieve best execution for clients.
THE PIMCO APPROACH
Scenario planning, yoga and other survival strategies
To explain how Pimco’s approach has helped it to thrive, Mohamed El-Erian cites the asset manager’s behaviour in the final days of Lehman Brothers. Pimco builds intellectual frameworks to interpret global events, with each piece of news slotted into a compartment, then scrutinised for meaning. “The minute you get more information, if suddenly it changes boxes, it’s incredibly important,” says Mr El-Erian, chief executive and co-chief investment officer.
The weekend before Lehman’s fall in September 2008, as rumours of its imminent demise circulated, Pimco had three scenarios for the investment bank, an important trading partner: a shotgun wedding to another institution; an orderly failure; or general disorder. It planned reactions to all three, but “we attributed the lowest probability to scenario C”, says Mr El-Erian.
It became clear on Sunday September 14 that disorder loomed. “At three in the morning our lawyers were there, at Lehman, delivering the notice of failure, which meant that we were able to reconstitute our swap positions [with other banks] very quickly,” he says.
Pimco also appears to benefit from inspiration that strikes Bill Gross, its outspoken co-founder and co-chief investment officer, who personally manages the $238bn held in the world’s largest mutual fund. While practising yoga one day, Mr Gross decided to send credit analysts around the country posing as property buyers. Their reports of excesses led to a conclusion as early as 2005 that the market would crash. This helped Pimco largely to avoid subprime losses.
“It sure helped solidify our case in a bond investor’s mind that says, ‘sometimes I’m not so much concerned about the return on my money, it’s the return of my money’,” says Mr Gross. His latest big bet is to sell all the US government securities held by the Total Return Fund. Mr Gross argues that yields are just too low to justify the risk from inflation, which erodes the value of bonds.
Yet even given Pimco’s success and the fact it has a sales force that puts it in touch with swaths of the institutional investing world, the company has failed to extend beyond its bond investing roots. It tried to expand with the purchase announced in 1997 of Oppenheimer Capital, a New York-based fund manager. The deal added $60bn in mostly equity-based assets to Pimco’s $20bn of equities and $110bn in fixed income.
Once Pimco was bought by Allianz in 2000, however, attempts to expand within the German insurer’s Allianz Global Investors met with little success. Today, many inside and outside the company recognise that the best thing Allianz did with its new asset was to leave Pimco alone.
Scenario planning, yoga and other survival strategies
To explain how Pimco’s approach has helped it to thrive, Mohamed El-Erian cites the asset manager’s behaviour in the final days of Lehman Brothers. Pimco builds intellectual frameworks to interpret global events, with each piece of news slotted into a compartment, then scrutinised for meaning. “The minute you get more information, if suddenly it changes boxes, it’s incredibly important,” says Mr El-Erian, chief executive and co-chief investment officer.
The weekend before Lehman’s fall in September 2008, as rumours of its imminent demise circulated, Pimco had three scenarios for the investment bank, an important trading partner: a shotgun wedding to another institution; an orderly failure; or general disorder. It planned reactions to all three, but “we attributed the lowest probability to scenario C”, says Mr El-Erian.
It became clear on Sunday September 14 that disorder loomed. “At three in the morning our lawyers were there, at Lehman, delivering the notice of failure, which meant that we were able to reconstitute our swap positions [with other banks] very quickly,” he says.
Pimco also appears to benefit from inspiration that strikes Bill Gross, its outspoken co-founder and co-chief investment officer, who personally manages the $238bn held in the world’s largest mutual fund. While practising yoga one day, Mr Gross decided to send credit analysts around the country posing as property buyers. Their reports of excesses led to a conclusion as early as 2005 that the market would crash. This helped Pimco largely to avoid subprime losses.
“It sure helped solidify our case in a bond investor’s mind that says, ‘sometimes I’m not so much concerned about the return on my money, it’s the return of my money’,” says Mr Gross. His latest big bet is to sell all the US government securities held by the Total Return Fund. Mr Gross argues that yields are just too low to justify the risk from inflation, which erodes the value of bonds.
Yet even given Pimco’s success and the fact it has a sales force that puts it in touch with swaths of the institutional investing world, the company has failed to extend beyond its bond investing roots. It tried to expand with the purchase announced in 1997 of Oppenheimer Capital, a New York-based fund manager. The deal added $60bn in mostly equity-based assets to Pimco’s $20bn of equities and $110bn in fixed income.
Once Pimco was bought by Allianz in 2000, however, attempts to expand within the German insurer’s Allianz Global Investors met with little success. Today, many inside and outside the company recognise that the best thing Allianz did with its new asset was to leave Pimco alone.
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