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Asset management: Conga contemplation

By Dan McCrum
Published: May 2 2011 21:47 | Last updated: May 2 2011 21:47

Listening mode: Bill Gross is finding ways to keep Pimco on its toes but will have to reconcile the
bond investor’s house view with a move into the rivalry and unruliness of equities

As he surveyed Pimco’s empty trading floor one weekend last summer, Bill Gross was struck by the thought that
the office atmosphere was too quiet. By the following Monday morning, the 66-year-old co-founder of Pimco, one
of the world’s largest asset managers, was leading a conga line around the trading desks of its normally hushed
headquarters in Newport Beach, California.

Every day since, at 8am, one song picked by an employee is played. Devil’s Haircut by Beck was a recent
selection. Then the room returns to the near-silent murmur that Mr Gross prefers.

For a company minding more than $1,200bn of other people’s money, Pimco is unusual in other ways, too. It is at
the end of the financial world by timezone, operating from sleepy Orange County, far from the blue-blooded fund
managers of the east coast. Yet little moves in the bond world without Pimco’s involvement. Much like Goldman
Sachs – another “best-of-class” financial company – Pimco is both revered and feared by its peers, many of
whom are wary of commenting in public. Its undoubted success in the bond markets has given it the reputation of
an ability to move and shape markets.

So as policymakers worldwide contemplate ending the long period of very low interest rates, and ponder bond
market tolerance for ever more government borrowing, the implications of Pimco’s every action for savers,
borrowers and even economies loom large. Rivals too are closely watching the firm’s reaction to the end of the
30-year bull market for bonds. Pimco has long been in the right place at the right time.

“There has been a generation-long cycle in government bonds,” says Jeffrey

Gundlach, chief investment officer for DoubleLine Capital, an asset manager. CLASS ACTION
“In 20 years’ time, December 2008 will be seen as the orthodox low point for In the summer of 2005 Pimco
bond yields.” Bond prices go up as interest rates go down, so since 2000, an was accused of applying
investment in a generic bond portfolio would have returned more than 80 per maximum pressure to a point
of weakness in the market for
cent, while the S&P 500 index lost a tenth of its value. US Treasury futures. A class
action suit bought by a group
Pimco thus finds itself at a crossroads. Much like a carmaker whose domestic of traders alleged that Pimco
market is saturated, it must look for new opportunities elsewhere. In the money manipulated the market,
management world this means gatecrashing other asset classes. Under the squeezing small traders by
taking large positions in related
stewardship of Mohamed El-Erian, chief executive since returning from an 18- securities at crucial times. In
month stint at the Harvard endowment in 2007, Pimco is starting with equities. response, the Chicago Board
of Trade introduced new
Yet if bond managers are sober savers patiently collecting interest, equity position limits in Treasury
investors are at the racetrack gossiping about form and punting on long shots. futures. Last year Pimco
The central question is whether Pimco can repeat its trick in equities – and agreed to settle the case for
$92m. The company has
whether it can even attempt to do so without destroying its carefully constructed always argued that it was
investing culture. simply acting to achieve best
execution for clients.
At Pimco – which began life in 1971 with three people and $12m – portfolio
managers are rewarded for their contribution to the firm’s overall performance,
rather than their pay being linked to revenues of a specific fund as is common elsewhere. Anyone judged as
being not up to scratch has money and responsibility removed, an approach that encourages what one
managing director calls “constructive paranoia”. Two-thirds of managing directors have held the job for less than
five years. Portfolio managers vote to commend individual contributions and elect some members of
management, and everyone has a chance to shine in the hunt for ideas.

Next week Pimco holds its three-day “secular forum”, an annual get-together to consider the big picture. Four
outside “thought leaders” are invited to speak, then on the final day the stage is handed to freshly hired MBAs.
“They haven’t yet drunk the Pimco Kool-Aid; they don’t know what the politically correct thing to say is,” says Mr
El-Erian.

But there are limits to Pimco’s democracy. Twin desks for the chief investment officers dominate the trading floor
from its centre, where their preference for e-mail over conversation sets the tone. The battle of ideas is also very
clearly refereed. “Bill and I bring it together”, says Mr El-Erian, “and it’s a bit like defining a motorway. It tells you
whether the motorway is going: north, south, east or west. It doesn’t tell you which lane you should be driving in; it
doesn’t tell you how fast you should be driving.”

Even a casual observer of Pimco’s inner workings would recognise, however, that the two set the rules of the
road. Mr El-Erian and Mr Gross alternately chair Pimco’s central decision-making entity, the nine-person
investment committee, or “IC”, which meets almost every day for two to three hours – a startling amount of senior
management time given to digesting the day’s new information.

In a long conference room next to the trading floor, shades drawn to block out
the California sun, television screens show a muted CNBC and a lonely THE PIMCO APPROACH
European representative beamed in from London. Conversation can be Scenario planning, yoga
combative, with the IC regularly challenged by members of three regional and other survival strategies
committees judged for their ability to influence and inform its thinking. However, To explain how Pimco’s
each debate has ultimately to return to Pimco’s framework for understanding approach has helped it to
the world, laid out in green ink on a whiteboard at the end of the conference thrive, Mohamed El-Erian cites
the asset manager’s behaviour
room. “All you’ve got to do is turn around and point, and people are pulled back
in the final days of Lehman
to the objective,” says Mr Gross. Brothers.
Pimco builds intellectual
Once the IC reaches a consensus, there is limited room for individual managers frameworks to interpret global
to stray far from the house view – and therein lies one of Pimco’s greatest events, with each piece of
challenges in equities. news slotted into a
compartment, then scrutinised
For instance, that framework described in green ink is a series of concentric for meaning. “The minute you
get more information, if
circles with money borrowed direct from the Federal Reserve at the centre, suddenly it changes boxes, it’s
representing maximum safety. It helped the company understand how investors incredibly important,” says Mr
flocked to safety in the crisis, with each ring outwards a step away from liquidity El-Erian, chief executive and
and towards risk. But only at the outermost edge of Pimco’s universe are stocks co-chief investment officer.
to be found, lumped in with homes, private equity, asset-backed securities, oil The weekend before Lehman’s
and high-yield debt. fall in September 2008, as
rumours of its imminent
Neel Kashkari, the man hired to build the new business, has a clear idea of the demise circulated, Pimco had
three scenarios for the
problem: “You can build a very efficient machine, but it won’t be very flexible, or investment bank, an important
you can build a very flexible machine that won’t be very efficient. Pimco is the trading partner: a shotgun
former.” wedding to another institution;
an orderly failure; or general
Clearly, the group can provide insight into the direction of currencies, interest disorder. It planned reactions
to all three, but “we attributed
rates and economic growth, which impact on more than just the bond market.
the lowest probability to
“It’s like Coca-Cola: not new Coke, but we can have Diet Coke,” says Mr Gross, scenario C”, says Mr El-Erian.
who argues that it can help make sense of the world for the institutions such as
It became clear on Sunday
pension funds, endowments and insurers that entrust money to Pimco. September 14 that disorder
loomed. “At three in the
The economic big picture dominates the company’s thinking, however. To morning our lawyers were
investors who argue that they take bets on individual assets rather than the there, at Lehman, delivering
direction of the economy, Mr El-Erian says bluntly: “You are putting on the notice of failure, which
meant that we were able to
directional trades; you just don’t know about it.”
reconstitute our swap
positions [with other banks]
However, equity investing requires more than a top-down view. “Pimco will very quickly,” he says.
need to build out stock-specific and sector research teams,” says Craig Pimco also appears to benefit
Siegenthaler, asset management analyst for Credit Suisse. “When actively from inspiration that strikes Bill
managing equities for third parties, it’s difficult to rely heavily on assessing Gross, its outspoken co-
broad economic trends. Instead, portfolio managers will rely more on stock founder and co-chief
selection within industries.” investment officer, who
personally manages the
$238bn held in the world’s
Furthermore, Pimco has advantages in terms of size and access that will be largest mutual fund. While
less available to it in stock markets, at least to begin with. But how aggressive practising yoga one day, Mr
its approach becomes will be instructive. Gross decided to send credit
analysts around the country
When trading, the firm appears unafraid to throw its weight around. It has posing as property buyers.
Their reports of excesses led
settled a class action suit bought against it by derivatives traders for alleged to a conclusion as early as
manipulation of the futures market in Treasury paper in 2005 that prompted 2005 that the market would
regulatory changes to the way that market operates. And, like other very large crash. This helped Pimco
asset managers, it receives begrudging professional respect from others as a largely to avoid subprime
skilled and hard-nosed participant in the trading games played between losses.
consenting adults. “It sure helped solidify our
case in a bond investor’s mind
“They are not afraid to spray the street,” says a bond trader for one large bank, that says, ‘sometimes I’m not
so much concerned about the
describing the practice of issuing simultaneous buy or sell orders to several return on my money, it’s the
dealers at once, thereby moving the market. return of my money’,” says Mr
Gross.
Pimco is also well connected to policymakers. “We try and get as much His latest big bet is to sell all
information as possible,” says Mr Gross. “We participate in the Borrowing the US government securities
Committee [a group of investors that meets every three months to advise the US held by the Total Return Fund.
Treasury]. We have people like Richard Clarida [global strategic adviser] and Mr Gross argues that yields
Andrew Balls [head of European portfolio management], who like to have lunch are just too low to justify the
risk from inflation, which
with central bankers – I don’t think it’s inside information if it’s said at lunch and erodes the value of bonds.
it’s all above board,” he adds. Mr Balls, a former Financial Times journalist, is
Yet even given Pimco’s
frequently the London face beamed into the IC conference room.
success and the fact it has a
sales force that puts it in touch
In equities, however, Pimco will face established rivals with their own networks with swaths of the institutional
of contacts and trading heft. BlackRock, the world’s largest asset manager and investing world, the company
one of Pimco’s main rivals, managed to move away from its bond investing has failed to extend beyond its
roots, but only by splashing out on large acquisitions: first Merrill Lynch’s asset bond investing roots. It tried to
expand with the purchase
management arm in 2006, then Barclays Global Investors in 2009. announced in 1997 of
Oppenheimer Capital, a New
Pimco is committing resources to the effort. Mr Kashkari is the first outsider York-based fund manager.
hired at managing director level. The former Goldman Sachs banker was The deal added $60bn in
picked for his experience at the Treasury in establishing the Troubled Asset mostly equity-based assets to
Pimco’s $20bn of equities and
Relief Program, which propped up the US economy after the 2008 collapse of
$110bn in fixed income.
Lehman Brothers.
Once Pimco was bought by
Allianz in 2000, however,
Of Pimco’s 1,800 employees, 75 so far work directly in the equity business, attempts to expand within the
enough to look after more than 10 times the less than $4bn equity assets under German insurer’s Allianz
management currently. Global Investors met with little
success. Today, many inside
and outside the company
recognise that the best thing
Allianz did with its new asset
was to leave Pimco alone.
“It’s very, very difficult [to diversify] but Pimco has a significant advantage in a strong brand name,” says Credit
Suisse’s Mr Siegenthaler. If Pimco can demonstrate good performance, it should be able to attract money to the
new business from existing investors.

The move may also reflect a subtle change within money management. Denis Bastin, a consultant to asset
managers, compares today’s uncertain environment to the 1970s, where picking the right asset class was far
more important than the individual stocks or bonds chosen. “We’re coming back to the good old-fashioned, broad
mandate that UK pension funds used to enjoy.” The big opportunity, Mr Bastin argues, is to move from selling the
big institutions narrow investment products to taking over responsibilities about where to invest as well.

For now, the company can start small, with its equity staff picking ideas from what Mr Kashkari calls “the Pimco
buffet table”. But the unanswered question remains how to nurture and encourage an equity culture while the
business is dominated by career bond investors.

As Mr Gross puts it: “Bond people are half-empty people and equity people are half-full people. It’s like the
pessimist versus the optimist; the cold front and the warm front rotating. You get thunderstorms.”

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