Wednesday, December 3, 2014

Fall of the Bond King?

Mary Childs of Bloomberg reports, Fall of the Bond King: How Gross Lost Empire as Pimco Cracked:
Bill Gross, the 70-year-old king of bonds, rushed through the offices of his $2 trillion empire on a Friday morning distributing hand-written notes. He knew his reign was over.

The billionaire co-founder of Pacific Investment Management Co. and its undisputed ruler for four decades was about to be overthrown. So just before 5 a.m. that day, on Sept. 26, he walked into Pimco’s headquarters in Newport Beach, California, and quietly placed notes on the desks of more than a dozen colleagues.

“Keep doing a great job,” Gross wrote on trade tickets used to buy and sell bonds. Of Pimco, he wrote: “Look after her.”

Gross’s exit -- an event that, not long ago, would have seemed unthinkable -- unleashed a crisis that Pimco is still trying to contain. His departure was followed by record withdrawals from the mutual fund he once ran, and which he built into the world’s biggest. Competitors swooped in, poaching clients from a firm that oversaw more assets in bonds than any competitor ever did. The government reached out to financial firms to ensure Gross’s departure didn’t destabilize the $100 trillion bond market.

Balls, Thimons

Interviews with 25 current and former Pimco employees, who asked for anonymity to discuss internal matters, paint a complex picture of the events that led to Gross’s departure, including details that have never before been published. The resignation in January of Pimco Chief Executive Officer and Gross’s heir apparent Mohamed El-Erian, 56, had prompted media reports of infighting at Pimco, and resulted in a management reshuffle that strengthened some of the firm’s younger executives. At the same time, Gross’s main fund was trailing competitors and clients had started to pull money.

Gross spent much of the past year hunting down employees who he believed were leaking information about the internal clashes to the press, according to the interviews. Among them were money managers Andrew Balls, one of Gross’s newly appointed deputy investment chiefs, and Joshua Thimons. Gross tried to fire both but his effort was thwarted by Pimco’s new CEO Douglas Hodge, 57, and President Jay Jacobs.

On at least three occasions, Gross proposed to step back as tensions within Pimco worsened.

September Showdown

Behind closed doors, the billionaire also opposed the firm’s expansion into stocks and real estate, areas seen by others as crucial to position the firm as the bond rally on which Pimco’s growth had been built showed signs of waning. In pushing for a return to a simpler business model, he questioned why the firm needed some of the executives it had hired.

By September, as Gross revived plans to fire Balls, 41, Pimco’s new senior managers turned against him. Several of the firm’s key executives offered to resign. When Gross proposed again to take a smaller role, give up management responsibilities and hand over his main fund to a successor by the end of 2015, Pimco executives were considering his ouster.

Rather than suffer the humiliation of being fired, Gross decided to walk away from the firm that he had started in 1971. A few hours later on that Friday morning, he was on a plane bound for Denver to join Janus Capital Group Inc. (JNS), the money manager run by his former general counsel and operating chief Richard Weil, 51.

‘Enduring Legacy’

“Bill Gross left an enduring legacy at our firm and we are grateful for his contributions,” Pimco’s Hodge said in a statement. “At Pimco we are guided by a set of core values of putting our clients first, acting with integrity always, being respectful of each other and delivering excellence. This is the foundation upon which Pimco is built and these are the principles that will carry us forward into the future.”

Steven Shapiro, a spokesman for Janus with Communications Strategy Group, declined to comment.

Gross built Pimco with some of the best long-term investing track records, and was the face of the bond market with television appearances almost every day. Assets at the firm doubled between 2010 and 2013, making Gross one of the best-compensated money managers, with a bonus of about $290 million in 2013, a fortune even by Wall Street standards.

An Ohio native who graduated from Duke University with a psychology degree in 1966, Gross built a reputation unparalleled among mutual fund managers, with his main fund, the $162.8 billion Pimco Total Return (PTTRX), beating 96 percent of peers over 15 years, according to research firm Morningstar Inc. The fund has become a staple in the 401(k) retirement accounts of millions of Americans.

Vietnam Vet

His departure triggered a combined $60.5 billion in withdrawals in the past three months from Pimco Total Return, which at its peak in April 2013 was the world’s largest mutual fund, with $293 billion. Assets in the fund have since shrunk by 44 percent.

Gross, who spent three years in the Navy and served in Vietnam, was obsessed with performance. When his flagship fund trailed 77 percent of peers in 2011, he apologized to clients, calling it a “stinker” of a year and reassuring them he hadn’t lost his touch. After a rebound the next year, he examined his legacy in an investment outlook that said the careers of great investors were fueled by a credit expansion that may be ending, and that the real test of his investing prowess was yet to come.

“Am I a great investor?” he wrote in an April 2013 investment outlook. “No, not yet.”

Tensions Surface

A month later, the Federal Reserve indicated it would unwind its bond purchases. Gross miscalculated the impact of those actions, giving his fund its biggest loss in almost two decades. Pimco Total Return trailed 65 percent of peers in 2013, even as it beat its benchmark, according to data compiled by Bloomberg. Clients started to pull money that month, in May 2013, and have continued redeeming every month since.

Around this time, tensions within Pimco were boiling to the surface. In June 2013, Gross lashed out at then-CEO El-Erian in front of a dozen members of the firm’s investment executives. He said he had an investing record of more than four decades, and asked El-Erian what he could point to.

El-Erian, who received a bonus of about $230 million in 2013, was seen by some within Pimco as a shock absorber between Gross and other employees, according to three people familiar with the matter. As their relationship deteriorated, Gross agreed in an executive committee meeting to hiring a mediator to try to mend it. After a search and a scheduled meeting with the mediator, Gross backtracked and said he had never agreed to a mediation.

El-Erian Resigns

As El-Erian informed the firm in December 2013 that he was going to leave, Gross offered to step back instead. El-Erian, a contributor to Bloomberg View, stuck with his decision and on Jan. 21 announced his resignation. Soon after, Marc Seidner, a high-profile generalist fund manager and member of Pimco’s investment committee who had worked with El-Erian at Harvard University’s endowment, quit. Seidner passed up an opportunity to serve as one of three deputies to Gross, along with Daniel Ivascyn, 45, and Balls, choosing instead to join Boston-based money manager Grantham Mayo Van Otterloo & Co.

Those departures strengthened others in the firm and weakened Gross. Pimco named six deputy chief investment officers -- Ivascyn, Balls, Mark Kiesel, Virginie Maisonneuve, Scott Mather, and Mihir Worah -- and Gross promised that each would have “some empowerment that probably was lacking to some extent in the past.”

Standing Ovation

In the weeks that followed, Gross tried to close ranks. He spent more than 20 minutes before a firm-wide meeting to discuss the media scrutiny that had beset the company, a speech in which he disparaged El-Erian, according to two people. When he ended to a standing ovation from the audience, including Hodge and Ivascyn, at least one executive declined to rise. Thimons, a managing director outspoken in his objections to Gross’s leadership, disagreed with his comments and refused to stand, according to a person who was present.

El-Erian’s departure had prompted media scrutiny and reports of clashes between El-Erian and Gross. The Wall Street Journal cited one example where Gross complained that El-Erian wouldn’t let him run the firm’s entire $2 trillion in assets.

“I’m Secretariat,” Gross said, referring to the famous racehorse, according to the Journal. “Why would you bet on anyone other than Secretariat?”

To stop the reports, Gross set up interrogations of members of the investment committee, managing directors, and lower-ranking money managers. He carried around a three-ring binder of printed-out e-mails and hand-written notes to find out who was talking to the press.

‘Mr. X’

Among his suspects were Balls, a former journalist, and Thimons, the executive who had remained seated during the standing ovation and who had organized a going-away party for El-Erian. Gross sought to fire Balls, a move opposed by Pimco’s new executives. Gross gave in and agreed not to pursue the matter at that time.

“Andrew and Josh are senior and respected professionals at our firm, and we have complete confidence in their leadership and integrity,” Daniel Tarman, a Pimco spokesman, said in a statement.

Balls and Thimons didn’t return e-mails seeking comment.

Gross later told DoubleLine Capital LP’s Jeffrey Gundlach that he had been chasing a “Mr. X,” a person sympathetic to El-Erian who was trying to sabotage him by revealing internal conversations.
Angering Management

While clamping down on leaks inside the firm, Gross called Reuters in early March, telling the news organization that El-Erian had been trying to undermine him and that he was responsible for the Wall Street Journal article.

Gross apologized internally for speaking to Reuters. A month later, in an interview with Bloomberg Television, he angered his colleagues again by calling on El-Erian to explain the reason for his departure. That interview prompted Jacobs to call an emergency meeting of the executive committee without telling Gross. After the meeting, Jacobs told Gross that he’d been suspended from media appearances indefinitely, provoking an outburst by Gross, according to a person with direct knowledge of the situation.

Pimco managers worried that Gross was becoming increasingly uncontrollable in public appearances after he strolled on stage at Morningstar’s investment conference wearing sunglasses and referring to himself as the bond market’s Justin Bieber. He also made a lengthy allusion to the movie “The Manchurian Candidate,” suggesting he wished he could hypnotize journalists into writing positive things about him.

Deep Divisions

At one point, weeks after El-Erian’s departure, Gross was seen yelling at Hodge and Jacobs in a glass room just off the trading floor, in plain view of more than 60 people. Later, he told colleagues he’d staged the dressing-down publicly to intimidate others.

Amid the media scrutiny, Gross demanded public support from his colleagues for his role at Pimco. Hodge obliged in a “viewpoint” in August on the website extolling Gross’s investing prowess.

“We are unaware of any person who has created more wealth for more people in the history of fixed income investing than Bill Gross,” Hodge wrote.

The divisions within Pimco went beyond Gross’s media appearances and his management style. Gross’s view of Pimco’s future was increasingly diverging from that of management. He was unhappy with the expansion into equities and wanted to return to a simpler model.

Criticizing Cupps

Four years after a Bloomberg Markets article in which Gross said that stock-market returns would beat bonds, the firm’s equity business wasn’t meeting expectations, having gathered less than $3 billion into its four main mutual funds.

Gross argued the push wasn’t cost-efficient, that stocks and other assets were too expensive, that Pimco should retrench and didn’t need the staff it had hired to diversify.

During a strategy meeting in August, he criticized Wendy Cupps, a managing director and head of product management who was paid a bonus of about $50 million the year before, saying she was taking too much of a lead developing products without his consent. He said her products group was “stealing the firm,” according to a person who attended the meeting. The comments stunned other executives and prompted opposition.

Gross, who steered Pimco through the 2008 financial crisis unscathed, also criticized the acquisition of real estate assets, saying such assets would be difficult to sell.

Alaskan Cruise

The next day, on Aug. 20, Gross proposed to senior leaders he would step back if they agreed to his demand that Balls and Thimons, whom he referred to as “Mr. X” and “Mr.Y,” be fired. He asked for management to work on a formal proposal while he was on a two-week vacation.

In his absence, Pimco composed a power-point presentation listing Gross’s requests, among them fewer client-facing responsibilities and managing fewer accounts, according to two people familiar with the matter.

Gross had made efforts in the past to be a warmer boss. He chartered a cruise ship with his own money from San Francisco to Alaska and back in the summer of 2003, for more than a week of firm-wide bonding. The endeavor cost him about $10 million, according to one person who attended. Gross stayed up until dawn mingling with employees.

Even that team-building effort, remembered fondly by many of Pimco’s long-term employees, was marred by his expectations. When some employees with children asked if they could arrive late or leave early, Gross expressed frustration in a meeting with the managing directors, saying the employees were spoiled.

‘People Management’

“I’m not especially known for people management,” Gross said in an interview with Bloomberg News in June. “I am learning,” he said, comparing managing employees to raising children.

By September, as Gross returned from his vacation, tensions within Pimco were finally coming to a head. In a meeting with Pimco’s executive committee on Sept. 10, attended by executives including Hodge, Jacobs, Cupps, Worah and General Counsel David Flattum, Gross proposed that he would share his role with a co-chief investment officer and that they could start a search immediately.
Succession Plan

He would manage the Total Return fund with the co-CIO until Dec. 31, 2015 and then would transition his responsibilities to other managers before stepping down. He proposed that he would instead run Pimco’s Unconstrained and a few other select strategies. Gross also offered to step down from Pimco’s executive committee and the partner compensation committee that sets pay.

After Gross left the meeting, the executive committee continued talking and eventually discussed firing Gross, according to a person familiar with the contents of the meeting. The Pimco executives viewed the timeline offered by Gross as too long and lacking a clear succession plan for the remaining funds he managed.

That week, more than 100 investment professionals had gathered at Pimco for the quarterly Cyclical Forum, including Balls. Gross pulled Balls aside to urge him to resign for the good of Pimco. He also made his case to fire Balls at an executive meeting, and was told by Hodge that Gross wasn’t authorized to fire a managing director.

Seating Arrangement

After the forum, Gross devised a seating plan for a meeting of portfolio managers, relegating Balls, Ivascyn and Mather to the rows of the conference room instead of at the main table. The arrangement was perceived as a snub, according to a person familiar with the matter.

By now, key employees including Ivascyn, Jacobs and Cupps individually had told Pimco they were ready to exit.

As management debated what to do about Gross, Ivascyn emerged as a favorite to succeed him as CIO. His main mutual fund, Pimco Income Fund (PIMIX), had beaten 99 percent of peers in 2013.

Private funds, those not sold to retail investors, run by Ivascyn’s teams had raked in $3 billion in profit between 2010 and 2013, according to a former employee. Ivascyn got a bonus of about $70 million last year, a quarter of Gross’s.

The week of Sept. 15, Michael Diekmann, CEO of Pimco parent Allianz SE (ALV), had flown in from Munich and had breakfast with Gross at the Marriott Hotel in Newport Beach. He proposed a “sidecar” that Gross would manage under Pimco’s name in a separate structure, a proposal Gross agreed to, according to a person with knowledge of the matter. Diekmann, 59, said he would take the plan to Pimco’s management.

Losing Control

Later that day, Gross met with Hodge and Jacobs, who presented a plan to announce his retirement at year-end, praising his accomplishments over his long career. Gross asked about the “sidecar” structure he had discussed with Diekmann. Jacobs declined and instead offered that Pimco would help him start a new company or fund.

“That’s a bone even a dog wouldn’t pick,” Gross replied.

Allianz spokeswoman Petra Brandes declined to comment.

Gross knew he had lost control. He called DoubleLine co-founder Gundlach, a prominent bond investor who had been pushed out by TCW Group Inc. five years before. He also re-engaged in conversations with Janus’s CEO Weil about partnering with him.

Gundlach Meeting

When he met with Gundlach, 55, the next day, Sept. 17, at Gundlach’s house near Santa Monica, they discussed the possibility of employment. Gross said he’d be willing to work for $1, indicating they could work out details later, according to Gundlach. The two men parted without coming to a decision.

The following week, Gross’s last at Pimco, he was told there would be a meeting scheduled to discuss his future on Friday, Sept. 26, at 2 p.m. and management had all but decided to oust him.

He called Janus’s Weil, who said that the firm would have an office ready for Gross.

At 5:28 a.m. California time on Sept. 26, Janus announced that Gross was joining them to manage a start-up fund with about $13 million, surprising Pimco and Allianz and rattling markets.

Since then, some managers who had left under Gross have come back. Seidner rejoined Nov. 12. Jeremie Banet, who left in June to run a food-truck business, is back as an executive vice president. Nobel Laureate Michael Spence, who departed in February, is returning as a consultant.

Bonus Pool

Less than two weeks after Gross left, the firm announced it added five people to its equities team, reporting to Maisonneuve, CIO for equities. Hodge has said Pimco will announce more new hires in the near future.

The firm, which still has $1.87 trillion under management, has the money to pay for top talent. Gross and El-Erian together received about $520 million in bonuses last year, roughly a third of the entire payout pool.

Pimco has also introduced a 225 million-euro ($279 million) award program that applies to “all employees that are not participating in the Pimco profit pool,” Munich-based Allianz’s Chief Financial Officer Dieter Wemmer said on a Nov. 7 conference call.

As Pimco’s leaders work to restore calm, the Total Return Fund has beaten 99 percent of peers in the past month, as bonds rallied. Redemptions from the fund slowed to $9.5 billion in November, Pimco said yesterday.

Gross has resumed some of his earlier routine. Since Sept. 29, he has driven from his cliffside mansion in Laguna Beach to an office in a not-yet-finished building that’s almost identical to Pimco’s new headquarters, a five-minute walk down the street.

Soros Backing

His new fund has attracted more than $1.2 billion of client deposits since he started, according to a person familiar with the matter -- a fraction of the billions that flowed out of Pimco since his exit.

George Soros, the former hedge-fund manager famed for successfully betting against the Bank of England in 1992, committed $500 million to a separate account with a strategy similar to his unconstrained fund. Scott Bessent, Soros’s chief investment officer, visited Gross in Newport Beach the week after he joined Janus, according to a person familiar with the matter.

Soros’s firm saw an opportunity to invest with a talented money manager while he was still running a small amount of money, according to the person.
Chief Investment Officer also just published a long piece on the end of Bill Gross's era at Pimco. Entitled Fade to Black, it paints an equally complex portrait of the legendary bond king.

After reading these comments, you come away thinking this guy is extremely competitive and just like many über rich and successful money managers, he has an oversized and fragile ego which parallels that of very well-known hedge fund gurus.

The other thing that strikes me is how outrageously overpaid these Pimco managers are. I mean, I've criticized overpaid hedge fund managers and overpaid pension fund managers but the compensation doled out to Gross, El-Erian and others at Pimco is just ludicrous even if these figures are being questioned. That part of the money management industry totally disgusts me. Pay for performance, not asset gathering!

Having said this, there's no denying Bill Gross is a legendary bond investor with a long and envious track record. But as I keep stating on my blog, people should stop glamorizing these "gurus" and realize that even the best of the best suffer huge setbacks.

In my latest Q3 activity report on top funds, I discussed how Warren Buffett lost billions on IBM (IBM) and Coke (KO) in less than a week. In my last comment on hedge funds closing like it's 2009, I discussed how the plunge in oil prices dealt a huge blow to Carl Icahn's portfolio.

In fact, the rise and fall of hedge fund titans should be required reading for all institutional investors, especially those that treat money managers like rock stars who are immune to downfalls. That's just plain silly and if you're not grilling these guys hard year in and year out no matter how well they perform, you're not doing your job in upholding your fiduciary responsibilities.

The media loves pumping up superstar money managers and the circus that followed El-Erian departure from Pimco was truly pathetic. Who cares? If you ask me, both El-Erian and Gross come away looking like total arrogant jerks with huge egos.

As far as Pimco, it remains a great shop, and the performance of its flagship fund has bounced back nicely after Gross's departure, beating 99% of its competitors. I have no doubts that they have the talent to keep delivering exceptional results.

As far as Bill Gross, we're subjected to mundane articles on his "fabulous" life, but he too seems to be happy at Janus. More importantly, he recently came out tweeting that he thinks bonds are overpriced:
Bond fund manager Bill Gross thinks bonds might be expensive.

Early Tuesday, Bill Gross took to Twitter, commenting on the speech given Monday by New York Fed president Bill Dudley.

Gross noted that Dudley thinks that while the natural interest rate — or the rate at which the Fed's inflation and employment objectives are achieved — may be lower than they've been historically going forward, this rate could still be 3%-4%.

Interest rates are currently at 0%-0.25%.

Gross wrote that if Dudley is right about the natural interest rate, then bonds are overpriced by 2%-3%.

On Tuesday morning, the US 10-year yield was around 2.2% and the 30-year bond was near 3%.

Gross' comments come after Jeff Gundlach, who has usurped Gross as the "Bond King," told CNBC that Treasury bonds still look relatively cheap.

In the past, Gundlach has said that he doesn't think the Fed has any plans to raise rates.

And while last week Gundlach told CNBC that he thinks the Fed might raise rates next year "just to see what happens," he added that with Spanish 10-year bonds yielding less than 2% it seems "almost unthinkable" that US Treasury yields would rise.

Gross, who unexpectedly left PIMCO back in September, did meet with Gundlach about joining his firm, DoubleLine Capital, but the two decided not to join forces.

Gundlach told CNBC that Gross joining DoubleLine was "sort of a 50-50 kind of proposition," but said that ultimately, he is okay with the decision because had investors asked him, after signing Gross, what the move meant for DoubleLine, he answer would have been, "I don't know."

Divergent views within a firm are common, if not healthy.

But Gundlach and Gross are the two biggest names in the bond world, and so given their split view of the bond market, maybe it's better that they're not working together.
I happen to agree with Gundlach on all fronts, including his decision not to partner up with Gross.

As I explained in my comment on preparing for a deflationary boom, the biggest mistake investors will make in 2015 (once again!) is focus too much on U.S. data, totally underestimating the risk of deflation spreading throughout the world and eventually coming to America. Moreover, the surge in the mighty greenback risks reinforcing U.S. deflationary pressures, raising concerns at the Fed.

Importantly, as long as deflation headwinds pick up throughout the world, there will be a natural cap on U.S. long bond yields because foreign investors will keep scooping up Treasuries. And if inflation expectations keep dropping in Europe and the U.S., don't be surprised if bonds continue to perform well. This is why I'm not on the same page as the Caisse and others souring on debt.

As always, I welcome your feedback either here or on Seeking Alpha where I also post my market comments. If you prefer, you can contact me by email at LKolivakis@gmail.com.

Also, when it comes to bonds, I urge you to keep reading the brilliant comments Brian Romanchuk posts on Bond Economics. His latest comments on why the JGB market ignored Moody's downgrade, Why not deflation? and his Fed Outlook for 2015 are all well worth reading.

Brian shared these insights with me:
I am probably fairly close to Gundlach's view - if the Fed hikes rates, the curve will flatten. That could keep the long end roughly where it is now. The problem is that such a view may be too complacent; we normally get a good back up in yields when the Fed hikes rates. So I do not exactly want to run around saying that bonds are a great buy right now.
Below, Bill Gross ended his four decade tenure at Pimco on September 26. Bloomberg’s Mary Childs chronicles his final days at the firm and the events that led to his departure from the company he created. Jason Trennert, managing partner at Strategas, joins the conversation on “Bloomberg Surveillance.”

And equity markets are going higher worldwide, says Laurence Fink, BlackRock chairman & CEO, discussing how the drop in crude will likely impact global markets and providing his outlook on bonds.

Update: Janus Capital's Bill Gross discusses what it's like to start over at 70 and looks at the impact of falling oil on markets around the world (15-12-14).



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