Pimco Dissidents Challenge Legend Gross in ‘Happy Kingdom’

Jul 08, 2014 10:28 am ET

(Adds asset class returns in 19th paragraph.)

July 8 (Bloomberg) -- In the weeks leading up to Pacific Investment Management Co.’s annual forum in May that sets the firm’s long-term investment outlook, Bill Gross was facing internal dissent.

At investment committee meetings in April and May, four of his six newly appointed deputy investment chiefs questioned whether their boss, manager of the world’s biggest bond fund and an investing legend, was too pessimistic about the economy. Mark Kiesel, Pimco’s head of corporate bonds, said that the U.S. energy industry would help propel faster growth than expected and that employment was stronger than his colleagues were seeing, according to four people familiar with the matter.

The debate, at a firm where dissidents in the past faced mockery or worse if they challenged the bond king’s views, had been encouraged by Gross himself, who has been battling criticism of his autocratic leadership style since the surprise resignation of his former heir apparent Mohamed El-Erian in January. Yet his deputies may also have been emboldened for another reason: most of them -- Kiesel, mortgage expert Daniel Ivascyn and Europe chief Andrew Balls -- are beating a majority of rivals this year. Gross, 70, is trailing peers in his main fund for a third year in four.

“It’s time for Pimco to be driven less by Gross’s strong personality and more by strong team performance,” said Erik Gordon, a professor at the University of Michigan’s Ross School of Business. “Bill and his vicissitudes have become a distraction from what investors want from Pimco. They want performance.”

Reshaping Pimco

Pimco, based in Newport Beach, California, is seeking to reshape itself after a tumultuous period. The firm, which had surged to $2.04 trillion in assets in March 2013 from about $400 billion a decade earlier, has shrunk by $100 billion since then through March 31, in part because of wrong-way calls by Gross on the economy. His Total Return Fund has declined to $225.2 billion from a peak of $293 billion in March 2013, as investors pulled money for 14 straight months, the longest streak of redemptions. Rivals such as BlackRock Inc. attracted new money into key bond strategies in the same period.

The discord culminated in the surprise departure of El- Erian this year, who left amid reports of clashes with Gross that painted the Pimco co-founder as an autocrat who didn’t tolerate dissent. Gross had previously said on several occasions that he could run Pimco’s $2 trillion in assets on his own, if only El-Erian would let him, according to a person with knowledge of the matter, who like the others, asked not to be identified because the meetings were private.

‘Bond People’

Pimco, a unit of Munich-based insurer Allianz SE, responded to the departure by appointing six deputy investment chiefs, who take turns heading the investment committee meetings that Gross used to control, and by allowing more debate, according to three of the people.

“The investment committee had been dominated by bond people,” who tend to be the type of people who see the proverbial glass as half-empty, Gross said in an interview June 19 in Chicago. With the deputy CIOs and Anthony Crescenzi, market strategist and executive vice president, Gross said “the committee is more evenly balanced in terms of optimism and pessimism.”

At meetings, Kiesel has expressed optimism about a U.S. recovery as it experiences an energy revolution, as the private sector heals and employment is growing, said four people with knowledge of the discussions. Pimco equities chief Virginie Maisonneuve has asserted that stocks will rise faster than the 5 percent rate predicted by Gross. Ivascyn said home prices will rise 3 percent to 5 percent per year for the next two years.

Beating Gross

The managers have done better than their boss this year relative to peers, albeit in funds with different mandates from Total Return. Ivascyn’s Pimco Income Fund, rated five stars by Morningstar Inc., has beaten 97 percent of its peers in the past month and year, and is ahead of 99 percent over the past five years, according to data compiled by Bloomberg.

Kiesel’s $5.2 billion Pimco Investment Grade Corporate Fund has surged 6.2 percent this year, beating 69 percent of similarly managed funds, bouncing back from last year when it trailed 66 percent of competitors, data compiled by Bloomberg show. Balls’s $3.2 billion Pimco Global Advantage Strategy Bond Fund has advanced 6 percent this year, ahead of 84 percent of similar funds, the data show. That’s an improvement from last year, when the fund was trailing 56 percent of peers.

‘Happy Kingdom’

“It’s a happy kingdom -- the only happier one is 15 miles north in Disneyland,” Gross said. “However, what I tell clients is our objective isn’t a happy Pimco, it’s a happy client. They want results for their money.”

The new openness is a balancing act for Gross, whose own calls haven’t played out this year. His Total Return fund has advanced 3.2 percent in 2014, worse than 57 percent of competitors. He trailed 66 percent of peers last year and 75 percent in 2011. In the past 12 months, the fund has climbed 4.3 percent, ahead of 55 percent of competitors.

Gross is betting on five-year Treasuries, which are more sensitive to changes in the central bank rate than longer-dated bonds, saying markets are overestimating how much the Federal Reserve will raise interest rates. Intermediate-term bonds reflect market expectations for Fed rates of as much as 4 percent, so the notes will outperform when investors realize that the central bank can’t raise borrowing costs much, he argues.

That view is not a popular one in the industry. While many bond managers agree interest rates will be lower, with the federal funds target ranging somewhere between 3 percent and 4 percent by 2018, Gross sees it at just 2 percent.

Goldman, BlackRock

Bond managers from Goldman Sachs Group Inc. to BlackRock and JPMorgan Chase & Co. are shunning shorter-dated bonds on the belief that such debt will suffer when the Fed lifts borrowing costs. Goldman Sachs brought forward its forecast for the Fed to raise interest rates, saying in a July 6 report that the central bank will raise its benchmark in the third quarter of 2015 rather than in the first three months of 2016.

Within Pimco, both Kiesel and Balls have a higher concentration of assets in longer-dated bonds, which have proven to be a far better bet than short-term debt this year. Kiesel has 71 percent of the fund in securities that mature in 5 to 20 years, and Balls has 68 percent in such debt.

Market Returns

The Bloomberg U.S. Treasury Bond Index for 1- to 5-year debt has advanced 0.6 percent this year, compared with a 3.1 percent increase in the corresponding index that tracks 5- to 10-year Treasuries. The index for debt maturing in 10 years and later has surged 9.9 percent this year.

Investment-grade bonds have returned 5.4 percent this year through yesterday, according to Bank of America Merrill Lynch index data. Mortgage-backed securities have returned 3.5 percent, the data show.

Kiesel’s investment grade corporate fund, which has 23 percent of its assets in debt issued by banks, benefited in the first quarter from financial-company bonds and debt issued by lower-rated pipeline operators, according to a quarterly report. Balls’s Global Advantage fund was helped by overweight positions in Spain, Slovenia and Italy, as well as a rebound in the Brazilian real and the Mexican peso, a fund report shows.

Deputies Empowered

Ivascyn, whom Morningstar named U.S. fixed-income fund manager of the year for 2013, has benefited from a bet on mortgage-backed securities, especially non-agency debt, according to a quarterly investment report. The Income Fund has 41 percent of assets in mortgage-backed securities and 30 percent in emerging-market debt. Ivascyn’s fund has a 13 percent short position in U.S. government-related securities, meaning he is betting against them. Gross’s Total Return has 50 percent of assets in government debt.

Like Gross, Ivascyn has a higher concentration of assets in shorter-term bonds. He has 56 percent of assets in bonds that mature in less than five years, compared with 53 percent for Gross’s Total Return.

With the deputy CIOs, “it’s about empowerment, expanding the scope of the investment committee process and the range of ideas in recognition of the firm that we have become,” Pimco Chief Executive Officer Doug Hodge said in a telephone interview July 7. “It’s not just about Total Return; it’s about all these other strategies and assets we manage literally all over the world.”

Pimco has prided itself on being a thought leader and a place for intellectual discourse, said Kurt Brouwer, chairman of Tiburon, California-based Brouwer & Janachowski Inc., who has invested in Pimco funds since the 1980s.

New Building

“If it were 2005 and bonds were on a good roll, then the thing about Mohamed and whatever else came up would be long past,” he said. “That came along at a time when many people were concerned about their fixed income allocation in general, so you’ve got both sides of the question.”

The turbulence at Pimco coincided with a big investment in the firm’s future, the move to a new building in May, across Newport Beach’s shopping enclave known as Fashion Island. The new office, which accommodates employees previously housed in two separate buildings, boasts hydraulic desks that can be made into standing workstations, and a cafeteria called the Coastal Café that offers a salad bar, made-to-order smoothies and fresh fruit. The 375,0000-square-foot space has a fitness center and a conference center that can accommodate 150 people, connected via video to all Pimco offices around the world, with a microphone at each seat so everyone can chime in.

The bigger forum meetings, which are held several times a year, now take place in a room with a round table, rather than a rectangular one as in the past. Previously, Gross said investment committee meetings, held four times a week, were often controlled by the “two big pillars” of Gross and El- Erian.

‘On Me’

“People had been silent, afraid, to put strong words on it, to piss one of us off,” he said. “That’s on me, I guess, in terms of not understanding that.”

In public, Gross’s tolerance has limits, particularly if his deputies deviate from the official company view. After Scott Mather, head of global fund management, said on Bloomberg Radio in April that the firm was moving away from its “new normal” thesis, Gross undercut him a week later, saying on air that Mather was “over his skis” and the new normal was alive and well.

Internally, Gross has tried to close ranks, spending more than 20 minutes talking about the media scrutiny that had beset the firm before its secular forum meeting in May, according to two people. He made it clear that he wanted no more leaks to the press, the people said.

Trusted Allies

He has recruited some of his most trusted allies back to Pimco, including Paul McCulley in a newly created role of chief economist, and Sudi Mariappa, rehired as a generalist fund manager to take over responsibilities after the January departure of Marc Seidner, who worked under El-Erian at Harvard Management Co.

As he seeks to project a more upbeat and approachable image of himself, Gross strolled on stage at Morningstar’s investment conference last month in sunglasses to give the keynote address. He admired himself on the screens as a “pretty cool dude” and called himself the bond market’s Justin Bieber. In a 50-minute speech, he reiterated the image of Pimco as the “happy kingdom.”

He also made a lengthy allusion to the movie “The Manchurian Candidate,” suggesting he wishes he could hypnotize journalists into saying that he is “the kindest, bravest, warmest, most wonderful human being you have ever met in your life.”

“Hopefully that will work,” he said. “Maybe not.”

--With assistance from Alexis Leondis in Washington.