The departure of William H. Gross from Pacific Investment Management Co. LLC leaves money management companies and institutional fiduciary clients alike wondering whether they should encourage the star system or a team approach to managing money.
Neither structure necessarily leaves asset owners less vulnerable as clients.
Mr. Gross was a star, the master of the universe in the fixed-income market, the king of bonds. With some $400 billion under his management, Mr. Gross' departure could cause a major upending of fixed-income investment management, not least by discouraging the star system in the future.
A star system in investment management leaves institutional clients vulnerable to such upheavals.
Fiduciary clients often create a bond with a firm or star like Mr. Gross, creating a loyalty that can cloud judgment.
Clients should be upset with Mr. Gross for abruptly breaking that bond and walking out on them as well as at PIMCO for not resolving issues with Mr. Gross or managing his departure better.
But fiduciaries should never let a manager's reputation, or rave reviews of a manager's capabilities, leave a firm untouchable. Doing so makes asset owners sitting ducks, vulnerable to being whipsawed by reacting to sudden changes in the organization's structure, personnel or investment models.
Asset owners were particularly at risk from the PIMCO upheaval. PIMCO wasn't just any money manager employing a star. For many asset owners in terms of their assets under management by PIMCO, the firm was one of the largest managers in their stable of external managers. For clients, the risk was that a disruption involving Mr. Gross and PIMCO would affect performance, or cause a change in management firms with all the associated transition costs.
Asset owners cannot control or time such upheavals. But they can manage the impact of them better. They can mitigate risk by avoiding concentration of assets with any single manager by the tried-and-true way of diversification. Doling out their assets to more managers would spread the risk and make them less vulnerable to the costs generated by organizational changes at any single firm.
Fiduciaries should question a firm's succession planning and temptations for any star, even Mr. Gross, a founder of PIMCO, to leave.
Mr. Gross is only the latest sensational example. Among others, Jeffrey E. Gundlach was a star in fixed income at TCW Group Inc. In 2010, he left the company to form his own firm, DoubleLine Capital LP. That move caused a shifting of clients from TCW, which led Societe Generale Group to sell the firm to The Carlyle Group.
Fidelity Investments' Magellan fund became famous for its outperformance starting with Peter Lynch. When he left, Fidelity went through a succession of stars, never quite reproducing the cachet of Mr. Lynch.
But asset owners can take only a little more solace in other organizational structures.
A team approach can be vulnerable to disruption, such as by the potential for liftouts of entire teams that have developed star reputations.
A team approach can stifle individual initiative and creativity. By suppressing recognition, firms using a team approach can drive out members, either to competitors more willing to embrace individual achievement or to their forming new firms.
Even quantitative approaches become subject to breakdowns, putting clients at risk.
AXA Rosenberg Investment Management caused an upheaval among clients because of a suspected coding error in the firm's investment model that might have affected performance. That issue cost clients millions of dollars in underperformance. Within a few months in 2010, AXA Rosenberg lost more than half of the assets it managed, falling to $32 billion because of client defections.
Paying for a “star” in whatever form — an individual or team or investment model — is no assurance of a desired outcome, even though it is a cornerstone of the business practice and compensation structure as well as marketing of investment management.
The “reliance on stars is a highly speculative management policy because we don't really know very much about what drives outstanding individual performance,” Boris Groysberg wrote in his book, “Chasing Stars: The Myth of Talent and the Portability of Performance.” In the book, Mr. Groysberg, the Richard P. Chapman professor of business administration in the organizational behavior unit at the Harvard Business School, researched the practices at Wall Street firms involving securities analysts.
“The basic resources in any company is people,” Gary Becker, the Nobel laureate observed, Mr. Groysberg noted in the book.
Knowledge workers “own the means of production,” Peter Drucker, the management expert, pointed out as noted by Mr. Groysberg in the book. “They carry that knowledge in their heads and therefore can take it with them.”
How much are portfolio managers free agents with portable skills?
Mr. Groysberg's examination challenges the human capital theory of portability.
Fiduciaries have to question how much, as Mr. Groysberg wrote, “of individual performance is specific to a particular workplace and not readily transferable elsewhere.”
That issue goes to the heart of investment management business practice and fiduciary responsibility.
To paraphrase Mr. Groysberg, a firm could risk paying more than an individual turns out to be worth to the firm and clients risk relying too much on an individual or single investment management process than it is worth to them.
With PIMCO, fiduciaries had warning of transformation at the firm with departures of senior staff.
Neel Kashkari left in 2013 as head of global equities to run for governor of California. In January, Mohamed El-Erian left as CEO and co-chief investment officer.
People, whether an individual or an investment team, change or move on, just as the conditions assumed in an investment model change. Fiduciaries not only have to prepare for the eventuality of such change, but avoid as much of the risk from such change as possible by diversifying among managers and leaving no firm untouched by continued scrutiny.