Date: March 16, 2014

The Fall of the House of PIMCO… The Bill Gross Saga

Overview of PIMCO

Over the years, Pacific Investment Management Company or PIMCO has been the global leader in fixed income or bond management. Their Total Return Bond Fund was the largest mutual fund in the world with roughly a quarter of a trillion dollars until ceding to Vanguard late last year. It was the standard by which competitors were judged and dominated the 401K market. Although now owned by giant insurer Allianz, PIMCO has essentially been an autonomous unit since the sale.

With almost $2 trillion in assets under management (AUM), the firm didn’t grow so big because they were mediocre. While I have never been a big fan of their equity funds with good reason, their fixed income prowess was the envy of Wall Street for years and perhaps even decades.

Bill Gross – Rock Star, Media Darling & King

Along the way, PIMCO’s performance has turned its founder, Bill Gross, into a media darling and rock star in the industry. Whenever there is a Fed meeting, major economic announcement or serious geopolitical event, you can count on the media outlets lining up interviews one after the other. To be fair, Bill Gross has been the superstar driving the firm’s performance so his status had been well deserved and warranted.

There are few valid comparisons to Bill Gross in the investment industry because it’s unusual for a “master of the universe” in the investment world to have also been the firm’s founder and remain in charge of the investment process. Names like Warren Buffett (another article coming later this month); Peter Lynch and Steven Cohen (SAC) come to mind.

Buffett has been at it a long time and was “anointed” king of the stock market along with Peter Lynch decades ago. It’s Warren’s firm and he may very well be the Bill Gross of equities, or is Gross the Warren Buffett of fixed income? Peter Lynch worked for Fidelity and retired near the height of his career under his terms without drama, very different from Gross. Steve Cohen has been the public face of hedge funds for years, first as a hero with his eye popping performance and lavish lifestyle, but recently as villain during a massive insider trading scandal that almost took the firm down.

Getting back to PIMCO and Bill Gross, in investing, size matters. Early on, firms seek to attain critical mass for survival and then move on to the sweet spot of assets under management before succumbing to public rush with swells the firm or fund to unwieldy levels. I am always impressed when I see someone like Seth Klarman from Baupost return billions of investor dollars because he can’t find enough good investing ideas, doesn’t want to dilute performance and doesn’t really care about the additional fees. I guess in the mutual fund space that would be akin to a hard close on new dollars.

Growth of AUM and Bull Market in Bonds are Great… Until They’re Not

It is certainly not new news that PIMCO has grown into a behemoth with $2 trillion under management. But that growth was the first nail in a very long-term coffin unless they could really diversify away from fixed income. Just something to watch rather than take any action.

What helped PIMCO and Gross earn such an incredible long-term track record was a 30+ year bull market in bonds that ended in 2012. With no disrespect intended, anyone who recognized the trend and was a buyer on all dips had to do mighty nicely. But Bill Gross was and is not “anyone”. He had the ability to actively move PIMCO’s fixed income portfolios between sectors of the bond market as well as moving portfolio duration around to best express his views. In short, Gross was a bond timer extraordinaire!

Performance Issues and the Need for Viagra

Besides the bloated AUM and bond bull market ending, there were other, more timely issues as well. Normally a stalwart in the bond mutual fund rankings, PIMCO’s flagship Total Return Fund fell on its sword in 2011, trailing 69% of its peers according to Bloomberg’s research. For a rock star like Bill Gross to only beat 31% of his peer group is like Peyton Manning or Tom Brady failing to make the playoffs.

Something was wrong…

Bill Gross was uncharacteristically blindsided by the European debt crisis that saw a massive flight to quality in US treasury bonds. The outflows and year were so bad that Gross felt the need to let out a cathartic “this year is a stinker” in a letter to shareholders, an action I give him a lot of credit for taking.

After bouncing back okay in 2012, the bond market vigilantes laid the smack down on PIMCO’s bond funds and fixed income in general from mid May to late June. Its flagship fund ended 2013 with only its second yearly loss since its 1987 inception and worst year since the bond debacle of 1994. With 2011 still fresh in investors’ minds, the ATM machine of PIMCO Total Return was over. The fund was in need of some investment Viagra!

Forgetting about swelling AUM and a new bear market in bonds, on performance alone, after 2011 and 2013 PIMCO was no longer king of the jungle. They were reduced to being mere mortals, enough for me to begin the process of removing from my 401K clients’ fund line up.

The Public Soap Opera Begins

And if all that wasn’t enough, 2014 has seen a very public and embarrassing soap opera for the firm, first with the surprising resignation of the very well respected heir apparent, Mohamed El-Erian, and then the Wall Street Journal tell all by Greg Zuckerman based on interviews with current and former employees.

When El-Erian shocked the industry by calling it quits, my first reaction was that he knows the bond market is now in secular decline and although PIMCO has never been a quality equity shop, he doesn’t see a whole of opportunity in the equity space. I figured he was just trying to retire on top. Then Zuckerman’s bombshell hit.

Initially, I thought it was probably just sour grapes with shreds of truth. That was until Bill Gross himself came on CNBC to defend himself and PIMCO. Why not just let it be? The news cycle is so fluid that tomorrow would have brought another story. Why dignify it with a response? Unless, of course, that the majority of the story was true and you are really on the defensive.

I recently spoke with a colleague whose son used to work at PIMCO and he shared stories and opinions that pretty much substantiate what Zuckerman wrote about in the article. From the unusual quiet on the trading desk demanded by Gross to the fear of making eye contact to the ego maniacal behavior, it sends up warning sign after warning sign. From my seat, El-Erian had enough of Gross and the culture at PIMCO and cashed in his chips before the ship began to take on more water.

And if all that drama wasn’t enough, there was a bizarre Reuters article which Gross disavows where Gross is said to comment that El-Erian was “undermining” Gross and that Gross listened to El-Erian’s phone calls. The article goes on to imply that in some paranoid type fashion, Bill Gross was making a list of those were either for him or against him in the El-Erian war of words.

This is not some made for TV reality show on the Jersey shore or Beverly Hills. This is one of the most successful and well respected investment professionals and firms on earth.

Something is very wrong…

Damage Control Does More Damage

This week I was reading the latest edition of Investment News and smack in the middle of the paper, PIMCO bought the two page centerfold to announce its newest “constellation of stars”, their new deputy CIOs. Looking at it closer, it’s not from PIMCO, but rather it’s Bill Gross saying “Let me introduce you to…”

What has become abundantly clear to me is that PIMCO is anything but a collegial, team environment where dissenting opinions are encouraged and respected. This is a glorified, gigantic one man show, primarily in the fixed income space without a well thought out succession plan. Bill Gross is the chief, the king, the dictator in a market climate that has definitely changed for the worse.

Although I will continue to include the PIMCO High Yield Fund in my junk bond fund universe and may employ it every now and then where I can manage the position, the flagship Total Return Fund has either been removed from clients’ 401K line ups or is in the process of being removed. With so many good products in the marketplace, PIMCO’s flagship fund and other Bill Gross managed funds are simply not worth the risk for the potential reward.

I do hope PIMCO and Bill Gross straighten out their internal and external mess and return to their glory days. It’s good for investors as well as the industry.


Paul Schatz, President, Heritage Capital