Pimco: ‘Bonds are meant to be boring’

The portfolio managers and traders at Pimco had a name for the public dressings down and furious emails that many of them received from Bill Gross. They called it "friendly fire". For years the risk of these humiliations was tolerated as the price for working at the powerhouse of bond investing, under the man universally known as the Bond King. But then they were tolerable no longer.

The stories of Mr Gross's unusual behaviour have been well told. What is as remarkable is how Pimco's senior managers came to believe things that seemed inconceivable just a year ago: that Mr Gross was not only dispensable but a liability to the firm he founded 43 years ago.

Their move to fire him was the investment world's equivalent of a California earthquake. It was the result of a shift in the balance of power inside the firm at its base in the "Golden State's" Newport Beach, the roots of which are found in the actions of Pimco's clients and their advisers many months before last week's events began to unfold.

"I want my bond managers to be boring," says Greg Woods, vice-president at BPAS Fiduciary Services, a pension fund adviser, who decided a few months ago to withdraw the $1bn that his firm had placed with Pimco. "I've got four daughters. I've got enough drama at home, I don't need it from my bond managers."

Read MorePimco CEO says 'our DNA is fundamentally unchanged' after Gross

Bill Gross
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Bill Gross

Mr Gross's Total Return bond fund had swelled to almost $300bn after outperforming the bond market year after year for decades, and advisers and pension fund managers agreed that no one was going to get fired for recommending Pimco. But the resignation of Mr Gross's co-chief investment officer and heir apparent Mohamed El-Erian in January, along with portfolio manager Marc Seidner, who turned down the opportunity to be a deputy to Mr Gross, alarmed Mr Woods, as did reports of infighting. Mr Woods' Pimco holdings represented almost all of the fixed-income allocation in his clients' funds, a concentration that was typical of many smaller institutional investors but with which he had become increasingly uncomfortable.

Better to head for the door before the fire alarm goes off and everyone is running for the exits, he told his clients.

"To even bring up the possibility of changing the allocation to Pimco was blasphemy," Mr Woods says. "Up to this point, whenever you were setting up an allocation to fixed income, giving the money to Pimco was pretty much a done deal. I knew I would have to plant the seed early, that I would have to massage it out of clients' hands."

Institutional investors ruminate and rarely move rapidly, but events can unfold with a logic of their own. The resignations in January and a Wall Street Journal report exposing Mr Gross's demeaning behaviour towards colleagues were red flags to the network of investment managers, consultants and fund trustees who govern the public's precious savings. Almost overnight Pimco went from being a safe-looking firm that no one could possibly be fired for recommending, to one that trustees and advisers had to justify.

The chief executives of two bond fund management firms said they were asked over the summer to draw up information on where their own funds correlated and differed from Pimco's, suggesting that a sovereign wealth fund was planning to shift part of its fixed-income allocation away from Newport Beach to limit concentration risk.

Curtis Arledge, chief executive of BNY Mellon Investment Management, says concerns about diversification have moved to centre stage. "Clients are questioning whether they have historically allocated too much of their portfolio to too few managers," he says. "There are size limits to the investment decisions that any one centralised investment team should make, portfolio positions can become too large relative to the market and groupthink undermines the investment process."

Mr El-Erian's exit prompted many pension fund clients to put their Pimco investments on a routine "watch list", which would mean they paid extra attention to developments. Clients began interpreting Mr Gross's antics – such as appearing in sunglasses at a Morningstar conference, comparing himself to Justin Bieber and writing an investment letter to his dead cat – not as the typical whimsy of the brilliant investor they had followed for years, but as yet more red flags.

A perilous consensus threatened to build, aided by the whispers of rival firms: Pimco had too much drama, and everyone had too much Pimco.

Another factor was changing the balance of power within the firm: Mr Gross was underperforming Pimco. His flagship Total Return fund slipped into the bottom 25 per cent of its category by performance this year, as Mr Gross misread the likelihood of rising interest rates. It kept on suffering client redemptions while rival firms recovered from a miserable 2013 and saw money flowing back into their bond funds. Even before his departure last week, the total pulled out by investors approached $80bn over 17 consecutive months of outflows.

According to insiders, some portfolio managers became concerned that Mr Gross's shrinking fee revenue was going to cut the bonus pool for everyone else.

One of Pimco's biggest public defenders was California pension fund Calpers, which had $1bn with Pimco but it was not managed by Mr Gross.

Charles Skorina, who runs a recruitment firm for the investment management industry, says the number of CVs and calls from disenchanted Pimco employees rose throughout the year. "It started with one, and then I had five, and by summer some 15 or 20," he says. "There was a good deal of unhappiness at a firm that before people were very keen to work for."

The 70-year-old Mr Gross showed no inclination to retire. He tweeted in January, "I'm Ready to Go for Another 40 Years", although it only served to focus attention on his age. At the same time, Pimco executives were pushing forward the next generation of portfolio managers, impressing upon nervous clients that Pimco had a deep well of talent beyond its founder and public face.

According to people familiar with the conflict, both sides appeared to believe that they were not being given enough credit for Pimco's success: Mr Gross for steering its successful investments for four decades, the other portfolio managers and business executives for helping diversify the company away from core bond funds such as Total Return into other fixed-income strategies that were popular among investors.

Despite his pledge to change his management style, Mr Gross continued to be prone to angry outbursts and put-downs of other executives, with many of these directed at Douglas Hodge, who had replaced Mr El-Erian as chief executive, and some at the man who replaced him as chief investment officer, Dan Ivascyn. Mr Gross declined to comment for this article.

Disappointment at the Pimco founder's behaviour coalesced when the firm's 240 portfolio managers from around the world met in Newport Beach for the quarterly "cyclical forum" to debate investment strategy. Executives feared they might be heading towards a choice between Pimco's founder and the managers on which they were pinning hopes for the long-term future.

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In surreptitious meetings, the executive committee canvassed support for Mr Gross. Several senior portfolio managers, including Mr Ivascyn, threatened to quit if he was not pushed out, according to people familiar with the events. The committee planned to confront and forcibly retire Mr Gross last Saturday but he discovered the plan and was already plotting his dramatic departure.

Last Friday morning, before even submitting his resignation, Janus Capital announced Mr Gross was joining immediately to run a start-up bond fund. It was an announcement that seemed calculated to cause maximum damage to Pimco, eschewing the usual niceties of smooth transitions and amicable handovers, catching the fund manager and its parent company Allianz flat-footed, not to mention stunning the investment world.

"I had to double-check there wasn't another William H Gross," says the chief executive of one big fund manager.

One email, from Chuck Manning at Eaton Vance to an investment manager, was typical of those arriving in Pimco clients' inboxes within hours of the announcement. "Bill Gross is leaving PIMCO," the email began. "Major news with potentially major ramifications for our industry . . . no question. From an asset management perspective, the first instinct is to reach out to every adviser and offer a substitute or compliment [sic] to Pimco Total Return. I'm sure you have received an incredible volume of such correspondence."

Executives worked through last weekend to react quickly by scrambling sales staff and preparing marketing materials. The efforts to gently prise clients away from Pimco, which had begun in January, intensified. Some clients jumped quickly to other managers, whereas larger institutional clients, true to form, are taking time to ponder. Calpers and other US public pension plans, such as those in New York and Florida, which are examining their holdings, could set the tone for others to follow.

The months-long process gives Pimco some breathing space to explain its new portfolio management structure under Mr Ivascyn as CIO and introduce the three new managers of Mr Gross's Total Return fund. It also offers time to persuade them that the firm's formal investment process is what has made Pimco successful, not the overlay of Mr Gross's famed investment instinct.

Mr Ivascyn told the Financial Times: "What we are trying to do is put together the best accumulation of ideas across the analysts teams and if we can do that well – and I always use the analogy of a conductor of an orchestra – then good things happen." For the present, outflows appear to be largely by retail clients and are focused on the Total Return fund, which suffered a record $23.5bn in withdrawals in September, more than 10 per cent of its assets.

But Pimco has to contend with a series of knee-jerk downgrades by consulting firms that could have knock-on consequences for its ability to retain some institutional clients. Mercer, one of the biggest pension fund consultants, told its clients that Mr Gross's old funds no longer deserved an A grade. Firms such as Western Asset Management, BlackRock, Loomis Sayles, JPMorgan and Goldman Sachs, with the scale to take over multibillion-dollar mandates from Pimco, are hoping to take advantage.

For some advisers, however, the departure of Mr Gross might eliminate some of the uncertainty and drama, especially if not having to pay his reputed $200m-a-year salary frees money to share among the troops.

Mr Woods of BPAS says he is happy having switched his $1bn to another west coast firm, MetWest, but admits to being tempted to nibble at Pimco once again – if it stays out of the headlines.

"As for whether we would consider moving to Janus? No way in hell. I'm done with Bill Gross. Bonds are meant to be boring."

Additional reporting by Tom Braithwaite