Drama, poor performance haunt PIMCO

In less than two months, PIMCO has experienced a dramatic fall from grace that removed the firm from the recommended list of some investment consultants and put it on the watchlist of some asset owners.

That reversal of fortune began shortly after the Jan. 21 resignation of Mohamed El-Erian, CEO and co-chief investment officer, the heir apparent to PIMCO founder and its acknowledged leader, William H. Gross.

Newport Beach, Calif.-based Pacific Investment Management Co. has been plagued by poor performance in its flagship Total Return Fund, managed by Mr. Gross, who shared the co-CIO title with Mr. El-Erian.

But outbursts attributed to Mr. Gross earlier this month have raised fresh concerns.

“I'm so sick of Mohamed trying to undermine me,” Mr. Gross was quoted as saying in a March 7 Reuters story, claiming Mr. El-Erian was behind an earlier story in The Wall Street Journal that described a tense, deteriorating relationship between the two men over investment performance issues in 2013. Mr. Gross also implied in the story that he had been monitoring Mr. El-Erian's phone calls.

“It's kind of shocking what is occurring,” an investment consultant said about Mr. Gross' comments.

The consultant — who spoke on condition of anonymity — is worried Mr. Gross is not fully concentrating on his investment responsibilities. “We would be hard-pressed to recommend PIMCO to a client seeking a fixed-income manager,” said the consultant, adding he would not recommend PIMCO as a finalist or even include the organization in searches for new managers.

Other consultants say they have PIMCO on watch and are monitoring events. But although some said they have reservations about recommending clients do business with the firm, they added that PIMCO would be considered in searches for strategies with strong investment performance.

But consultants say their clients are also concerned. With PIMCO under a media microscope, asset owners are concerned that doing business with the firm could bring unwanted attention, possibly creating headline risk and/or job risk for them.

“Any time you have a management team at a money management firm generating this kind of negative press, it creates a problem,” said the CIO of a public pension fund with more than $1 billion invested with PIMCO. “It creates drama. I have had more than 20 press calls that I had to deal with.”

The CIO, who spoke on the condition of anonymity, said he has no plans to terminate PIMCO. He added, however, he would not give the manager a new allocation. Plus his fund has put PIMCO on a watchlist. The CIO added that he wonders whether PIMCO's leaders are able to concentrate effectively on investment performance given the distractions.

According to accounts from fellow employees, Mr. Gross has run a very top-down organization, making it clear he was in charge. Former employees familiar with both men said Mr. Gross' aggressive management style led to the conflicts with Mr. El-Erian.

PIMCO public relations staff refused requests for on-the-record interviews with Mr. Gross or other senior officials. In a statement, Thomas Otterbein, managing director and head of institutional Americas, said the firm continues to attract institutional clients.

“We have clear indications that clients and consultants continue to view us as a strong provider of investment strategies and solutions,” he said in the statement. “In fact ... we have been awarded more than $3 billion in new mandates (so far this year) across a range of strategies. In addition, we are regularly being included in search activity; more than 70 RFPs so far in 2014, a 15% increase over this time last year.”

PIMCO did not release flow numbers for its institutional strategies. But data from Morningstar Inc., Chicago, which tracks PIMCO open-end mutual funds including institutional-class shares, showed those funds had net outflows of $2.49 billion in February, the largest combined total in the industry for a fund group but not a big number. Those interviewed for this story attribute the February outflows to performance and a secular move away from fixed income. It's too early for the Gross-El Erian situation to be a factor, they said.

PIMCO's flagship Total Return Fund continues to suffer from poor performance. Last year, it lost its status as the world's largest mutual fund.

Around 65% of PIMCO's $1.9 trillion in assets are institutional. The firm has been a cash cow for parent Allianz SE, Munich, accounting for as much as one-third of Allianz' profits.

Meanwhile, competitors are seeing the Gross-El Erian drama as an opening to grab some business. One senior money management executive, who would only speak on background, said her firm's staff is aggressively calling on PIMCO's institutional clients in an attempt to convince them to switch managers.

And PIMCO executives have been mounting their own offensive. They have called or met with hundreds of their institutional clients, touting management changes that have resulted in six investment staffers being promoted to deputy CIO, all new positions.

Mr. Gross has said he remains engaged, tweeting on March 10, “No distractions here — just long-term performance satisfaction — working hard as always for clients.”

Phil Kapler, retirement plan administrator for the $3.9. billion Fresno County (Calif.) Employees' Retirement Association, said he was part of a group of public pension fund executives that met with new PIMCO CEO Douglas Hodge on March 11; the meeting was scheduled before Mr. El-Erian's departure.

Mr. Hodge told the group that media accounts of what had occurred at PIMCO were overdramatized. Mr. Kapler said Mr. Hodge stated there was no conflict between Mr. El-Erian and Mr. Gross, and that Mr. El-Erian decided to leave because he wanted a change.

He said Mr. Hodge said having six deputy CIOs will result in a flatter organizational structure and not so much command and control in one person's hands.

Mr. Kapler said Mr. Hodge offered a broader vision of PIMCO. He said officials would move the firm toward offering a full suite of investment strategies in a variety of asset classes and away from a straight core and core-plus fixed-income shop. (Past efforts by PIMCO to move beyond fixed income have met with limited success. After four years of seeking investors for active equities, those strategies make up less than 1% of the firm's total assets.)

Mr. Kapler said he came away from the meeting more impressed with the organization. He expects the board at its April 2 meeting to expand its relationship with PIMCO, hiring the firm for a tail-risk hedging overlay strategy for the entire pension fund.

“They've got the depth and breadth to manage the strategy,” Mr. Kapler said. ”We are not running away from PIMCO, we are getting in deeper with them.”

He called the watch status routine, done every time a firm has change in the senior executive ranks. Fresno County has around $100 million allocated to emerging markets debt with PIMCO.

Other pension executives are more skeptical of giving PIMCO new business. One at a large public pension fund said his fund recently allocated around $100 million to PIMCO for emerging markets debt, its first allocation to the firm. He said he wouldn't do that today, given the current situation, because it could lead to second-guessing by his board and the local press.

“If it doesn't work out, it looks like you don't know what you are doing,” he said.

Two consultants also expressed concern that Mr. Gross is stretching himself too thin. (He took over as portfolio manager of the $25.6 billion PIMCO Unconstrained Bond Fund in December, replacing longtime manager Chris Dialynas, who took a one-year sabbatical.)

Mr. Gross promptly changed the fund's strategy, according to the firm's website, selling 30-year Treasuries and a large portion of its agency mortgage holdings while increasing bets on corporate debt.

One consulting firm that has PIMCO on watch is Angeles Investment Advisors, Santa Monica, Calif. Michael Rosen, principal and CIO, said any time there is a change in senior management it has the potential to be distracting to the organization and affect the investment process.

Mr. Rosen said he has not put PIMCO on a unilateral blacklist; it depends on the strategy and specific investment performance. He said the PIMCO income strategy managed by Daniel Ivascyn, one of the new deputy CIOs, has done very well. Several clients are invested in the strategy, he said.

Mr. Rosen said PIMCO has a deep investment bench that goes beyond Mr. Gross, but in the end, what will make or break PIMCO is one thing. “It all comes down to investment performance,” he said.